Pound Weakens Versus Euro as CPI Stays Above Target; Gilts Fall

The pound fell to a one-month low against the euro after a report showed consumer-price inflation stayed above the Bank of England’s target at the same time as growth stagnates.

The U.K. currency dropped versus 13 of its 16 major counterparts and Britain’s government bonds declined for the first time in four days. Amundi, which oversees $947 billion, said the pound will stay under pressure because inflation exceeds interest rates, damping returns on British assets. Lawmakers eased the Bank of England’s remit in March to give it greater flexibility to add stimulus even if inflation remains above its 2 percent target.

“The fundamental outlook for the pound remains weak,” said Lee Hardman, a currency strategist at Bank of Tokyo Mitsubishi UFJ Ltd. in London. “The Bank of England is likely to further loosen monetary policy to support growth despite inflationary pressure. We see a rebound in sterling as an opportunity to establish a new short position.” A short position is a bet an asset will decline.

The pound fell 0.8 percent to 85.93 pence per euro at 5:04 p.m. London time after depreciating to 86.02 pence, the weakest level since March 15. Sterling advanced 0.3 percent to $1.5327.

The annual inflation rate was unchanged in March at 2.8 percent, the Office for National Statistics said. Core inflation, which excludes alcohol, tobacco, food and energy prices, accelerated to 2.4 percent from 2.3 percent in February. The Retail Prices Index, used as a basis for the inflation-linked bond market, was 3.3 percent, up from 3.2 percent.

Negative Rates

Britain’s growth is likely to be “sluggish at best” and further bond purchases by the Bank of England may do little to stimulate the recovery, the Ernst & Young Item Club said in a statement yesterday.

Sterling weakened 4.5 percent this year, the second-worst performance after the yen, according to Bloomberg Correlation-Weighted Indexes that track 10 developed-nation currencies. The dollar gained 1.9 percent and the euro advanced 1.8 percent.

The inflation rate exceeds the Bank of England’s benchmark interest rate of 0.5 percent by 2.3 percentage points. The so-called negative real interest rate, once inflation is taken into account, will weigh on sterling even as the currency is “undervalued,” according to Amundi.

“The BOE recently indicated that inflation would remain above the 2 percent target during the two following years and that it would not fight against it,” Amundi analysts including head of research Philippe Ithurbide in Paris, wrote in a note. “Real interest rates are likely to remain negative and the pound should not go back to its pre-crisis levels.”

Gilt Yields

The 10-year gilt yield rose three basis points, or 0.03 percentage point, to close at 1.73 percent after falling to 1.63 percent on April 8, the lowest since Sept. 5. The 1.75 percent bond due September 2022 declined 0.23, or 2.30 pounds per 1,000-pound face amount, to 100.165.

Inflation expectations declined, with the 10-year break-even rate, derived from the yield difference between gilts and index-linked securities, falling three basis points to 3.23 percentage points. The rate increased to 3.39 percentage points on April 11, the most since September 2008.

U.K. government bonds returned 1.5 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bonds gained 0.8 percent and Treasuries rose 0.9 percent.

BOE Minutes

The Bank of England will release the minutes of its April 3-4 policy meeting tomorrow. The nine-member Monetary Policy Committee led by Governor Mervyn King maintained the target for asset purchases at 375 billion pounds at the meeting and kept the benchmark rate unchanged.

With the weaker pound adding to inflationary pressure, it’s likely policy makers will be reluctant to expand the bond-buying target, according to Barclays Plc.

“The MPC has sensibly made it clear it will not act to bring inflation down more quickly, but in the context of a 2 percent inflation target, the case for additional monetary stimulus looks equally hard to make,” Simon Hayes, chief U.K. economist at Barclays in London, wrote in a client note.

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