U.K. Gilts Show Inflation Outlook Highest Since ’08; Pound Falls

U.K. inflation expectations climbed to a 4 1/2-year high amid speculation the Bank of England will add more stimulus, or quantitative easing, and sacrifice its 2 percent target to spur the economy.

The pound dropped to the lowest level against the dollar since June 2010 as data showed U.K. industrial and manufacturing production unexpectedly declined in January. Sterling weakened for a second day versus the euro. Gilts gained after the Royal Institution of Chartered Surveyors said house prices decreased in February. Two-year yields slid to the least since September.

“There’s a nervousness around that the government may be about to give the central bank a freer remit, which suggests inflation will tend to be higher,” said John Wraith, a fixed-income strategist at Bank of America Merrill Lynch in London. “If QE does make a comeback, if they review the remit and if sterling continues to weaken, then we will see higher breakevens almost certainly.”

The U.K. 10-year break-even rate, which measures the yield difference between gilts and index-linked securities, rose six basis points to 3.35 percent at 4:30 p.m. London time. It earlier touched 3.36 percent, the highest since September 2008.

The benchmark 10-year gilt yield slid five basis points, or 0.05 percentage point, to 1.96 percent. The 1.75 percent bond maturing in September 2022 rose 0.45, or 4.50 pounds per 1,000-pound ($1,488) face amount, to 98.165. The rate on two-year gilts slipped as low as 0.18 percent, the least since Sept. 28.

Carney Meeting

Bank of England Governor-designate Mark Carney met the U.K. Treasury’s top civil servant, Nicholas Macpherson, to discuss possible changes to Britain’s monetary policy making, said a person with knowledge of the talks.

They spoke about the options in Ottawa last week, according to the person, who declined to be identified because the conversation was private. Carney told U.K. lawmakers on Feb. 7 that he sees merit in making the inflation target more flexible.

The Monetary Policy Committee held its asset-purchase target at 375 billion pounds last week, a month after Governor Mervyn King and two other MPC members were outvoted in an attempt in a push for more stimulus. The next policy meeting will be on April 3-4.

“With some MPC members already convinced that some fine-tuning of QE, with additional 25 billion pounds, could be of some support for the sluggish economy, further weakness in hard data might lead to a vote for more QE already in April,” Annalisa Piazza, a fixed-income analyst at Newedge Group in London, wrote in an e-mailed note.

Rate Expectations

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

The pound fell 0.2 percent to $1.4880 after sliding to $1.4832, the lowest level since June 23, 2010. Sterling depreciated 0.1 percent to 87.58 pence per euro. It reached 88.15 pence on Feb. 25, the weakest since Oct. 28, 2011.

Production fell 1.2 percent from December, according to the Office for National Statistics. The median forecast in a Bloomberg News survey was for a 0.1 percent increase. Manufacturing slipped 1.5 percent in January. An index of U.K. house prices declined to minus 6 last month from minus 4 in January, RICS said.

The National Institute of Economic and Social Research today said it estimated that the economy shrank 0.1 percent in the three months through February.

Pound Momentum

“Momentum is clearly against the pound and if anything serves as an excuse to carry on the market takes it,” said Derek Halpenny, European head of global-markets research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “The weak data back up renewed quantitative easing and it’s a clear recipe for further pound weakness.”

Bank of Tokyo-Mitsubishi forecasts the pound will slide toward $1.40 within a year and it may “easily” reach that level within a couple of months, Halpenny said.

The pound has weakened 6.7 percent this year, the second-worst performer after the yen among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro rose 1.6 percent and the dollar gained 3 percent.

The Bank of England plans to buy longer-dated gilts today as it reinvests the proceeds of its asset-purchase program. The central bank said on March 7 it will purchase gilts with a residual maturity of three to seven years on Mondays, of more than 15 years on Tuesdays, and of seven to 15 years on Wednesdays.

This reinvestment is a “supporting factor” for gilts, acting as a mini form of quantitative easing, Lloyds Banking Group Plc strategists led by Charles Diebel in London wrote in an e-mailed note today.

Gilts lost 1.3 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bunds dropped 0.9 percent and Treasuries fell 1.1 percent.

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