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Toxic Cocktail Threatens Pound’s World-Best Gains, RBS Says

Current-account and fiscal deficits as well as growing political risks may prove a “toxic cocktail” for the pound’s world-beating gains, according to Royal Bank of Scotland Group Plc.

Investors should sell the U.K. currency against the dollar on a “tactical” basis, Paul Robson, a London-based senior strategist at the U.K.’s biggest state-owned lender, said by phone today. Robson correctly predicted at the end of January that sterling would add to gains versus the dollar that made it the best performer among major peers in the past 12 months. The pound broke a run of four straight losses against the dollar today and was little changed against the euro.

“Over the next 12 months, rising political risk and less favorable moves in rate spreads may see more intense focus on the twin deficits,” Robson wrote in an e-mailed note. “This is a potentially toxic cocktail for sterling. The pound may be slipping through $1.60 toward the end of the summer,” he said in a later phone interview. RBS is the seventh-largest currency trader, according to Euromoney Institutional Investor Plc.

Sterling advanced 0.2 percent to $1.6606 at 4:29 p.m. London time after declining 0.4 percent last week, the fourth weekly drop in five. The pound was at 82.74 pence per euro.

Losing Momentum

Britain’s currency fell against the greenback last week on signs the recovery is losing momentum. House prices dropped in March, according to an April 4 report from the Halifax unit of Lloyds Banking Group Plc. A gauge of service industries also declined in March, Markit Economics said on April 3.

The country’s current-account deficit, which measures the total imports and exports of goods, services and financial transfers, was at 22.4 billion pounds in the fourth quarter, compared with a record of 22.8 billion pounds in the previous three months, according to the latest report on March 28.

The Office for Budget Responsibility projects the underlying fiscal deficit this year will be 6.6 percent and 5.5 percent next year.

Voters will go to the polls for a general election in May next year.

Improving economic data has prompted bets the Bank of England, which meets this week, will bring forward plans to increase interest rates. The U.K. currency rallied 9.7 percent in the past 12 months, the best performer among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The dollar climbed 0.4 percent and the euro appreciated 6.9 percent.

Fully Priced

“The pound may have fully priced the good economic news, with markets looking for a February or March first Bank of England’s rate increase,” RBS’s Robson said.

All 50 analysts in a Bloomberg survey predict Bank of England policy makers will keep the benchmark rate unchanged at a record-low 0.5 percent. The decision is due on April 10.

“The pound is consolidating at higher levels,” said Derek Halpenny, head of global markets research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “The currency has lost some upward momentum and may need some upside surprises in economic data to move higher in the near term. But that doesn’t change our view that the pound will be underpinned by the recovery.”

Manufacturing output expanded 0.3 percent in February from the previous month when it rose 0.4 percent, according to the median estimate of analysts in a Bloomberg survey before the report is published tomorrow.

Gilts Returns

Benchmark 10-year U.K. government bonds rose for a third day, with yields slipping two basis points, or 0.02 percentage point, to 2.67 percent. The 2.25 percent bond due September 2023 climbed 0.13, or 1.30 pounds per 1,000-pound face amount, to 96.525. The rate on the two-year gilt slid one basis point to 0.64 percent.

The U.K. 20-year break-even rate dropped one basis point to 3.33 percent before the Debt Management Office sells 1.3 billion pounds of 0.75 percent index-linked bonds maturing in 2034. The break-even rate reflects the pace of inflation investors expect over the life of the securities.

Gilts returned 2.9 percent this year through April 4, according to Bloomberg World Bond Indexes. Treasuries gained 1.7 percent and German bonds rose 2.5 percent.

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