Pound Weakens Versus Euro on China Woes Before U.K. CPI Report

The pound declined for a second week against the euro as China’s surprise currency devaluation dimmed the outlook for inflation around the world.

That’s bad for sterling because slower growth in consumer prices may deter the Bank of England from raising interest rates and curb the allure of the currency. Data next week will show Britain is already in an environment of stagnating inflation, according to analysts surveyed by Bloomberg News. The report due on Aug. 18 may indicate why only one of nine policy makers voted for a rate increase this month.

With money-market derivatives showing traders aren’t expecting higher borrowing costs from the BOE until next August, two-year government securities rose, outperforming 10-year gilts for the first time in five weeks. Risks of global deflation were highlighted after China unexpectedly devalued the yuan on Aug. 11, days after data showed a slump in exports from the world’s second-largest economy.

“The move in sterling against the euro can be partly explained by a small shift in rate-hike expectations that’s a result of the yuan devaluation,” said Jeremy Stretch, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London. “But unless one thinks the impact of China’s move will be prolonged, the pound at this level is looking attractive.”

The pound depreciated 0.5 percent this week to 71.11 pence per euro as of 5 p.m. Friday in London. Sterling climbed 0.9 percent from Aug. 7 to $1.5623, the biggest increase since June 19.

Rate Outlook

Forward contracts based on the sterling overnight index average, or Sonia, signaled a 25 basis-point increase next August, compared with May as recently as Aug. 11. The BOE hasn’t raised its key rate since 2007 and the benchmark has been at 0.5 percent since 2009.

The five-year break-even rate, a gauge of market inflation expectation derived from yield difference between gilts and index-linked securities, declined for a seventh week, the longest falling streak since December 2008. The rate dropped four basis points, or 0.04 percentage point, to 2.34 percentage points.

The yield on two-year gilts dropped one basis point this week to 0.58 percent, while that on benchmark 10-year bonds climbed three basis points to 1.88 percent. That widened the spread by four basis points to 130 basis points, the first increase since July 10.

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