Pound Advances Against Euro on Italy Speculation; Gilts Decline

The pound strengthened against the euro amid concern Italy’s struggle to form a government may drag on the 17-nation currency bloc’s economic recovery, boosting demand for U.K. assets.

Sterling rose against all but two of its 16 major peers after a report showed U.K. house prices increased for the first time in nine months in February. Britain’s currency advanced from close to a 2 1/2-year low against the dollar even as an industry report showed U.K. construction output shrank. The 10-year gilt yield fell to a two-month low after the Bank of England said net lending to consumers and companies dropped 2.43 billion pounds ($3.66 billion) in the fourth quarter.

“The euro is trading more heavily against sterling following the Italian elections until we have more clarity,” said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. In the U.K. “we had disappointing construction data and also the latest report on the usage of the funding for lending scheme was relatively disappointing. We think both the euro and the pound will weaken further against the dollar over six-to-12 months.”

The pound appreciated 0.5 percent to 86.18 pence per euro at 4:44 p.m. London time. Sterling gained 0.2 percent to $1.5072, after sliding to $1.4986 on March 1, the lowest level since July 2010.

The yield on 10-year gilts rose three basis points to 1.90 percent after falling to 1.86 percent, the least since Dec. 31.

The rate dropped 24 basis points last week after inconclusive elections in Italy sparked concern lawmakers will fail to form a government, hampering the progress of austerity measures put in place by the previous administration.

Construction Slides

An index of U.K. construction activity fell to 46.8 from 48.7 in January, Markit Economics and the Chartered Institute of Purchasing and Supply said in an e-mailed report today in London. That’s the lowest since October 2009 and below economists’ forecast for a reading of 49, based on the median of nine estimates. A reading below 50 indicates contraction.

Bank of England policy makers meeting this week have said they are considering new measures to revive growth as the economy shows signs of slipping into an unprecedented triple-dip recession.

“Recent U.K. data have been much worse than expected, showing that the economy is struggling,” said Bernd Berg, a currency strategist at Credit Suisse Group AG in Zurich. “This gives plenty of arguments for the Bank of England to announce further monetary easing measures. The pound will therefore remain under intense pressure and fall towards $1.48.”

Rate Expectations

Money markets are factoring in a 25 basis-point cut in the central bank’s main rate by December, according to sterling overnight index average forwards, so-called Sonia rates, Tullett Prebon Plc data show. The bank’s key interest rate has been at a record-low 0.5 percent since March 2009.

Bank of England Governor Mervyn King, who will retire in June and will be replaced by Mark Carney, and two other policy makers were last month defeated in a push for more asset purchases, known as quantitative easing, according to minutes of the bank’s Feb. 7 meeting.

“There’s been a big surge in expectations for more QE especially since we got the minutes,” said Elsa Lignos, senior currency strategist at Royal Bank of Canada in London. “People say that in the past when Mervyn King, the governor, has voted for something, in the following month everyone shifted to join him. He’s on his way out. I don’t think we’ll get the same pattern playing out.”

Lignos, who spoke with Francine Lacqua on Bloomberg Television’s “On the Move,” expects the pound to strengthen against the dollar this year.

The pound has depreciated 5.3 percent this year, the worst performer among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. The dollar gained 3 percent and the euro rose 1.3 percent.

U.K. government bonds lost 0.2 percent this year through March 1, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bonds dropped 0.3 percent and Treasuries fell 0.1 percent.

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