Pound Climbs on Yield Jump; BlackRock Sees Gilts Risks

The pound advanced to its strongest level since 2008 versus the dollar as the fastest manufacturing growth in seven months boosted the prospects for higher interest rates that enhance a currency’s allure.

U.K. government bonds declined as BlackRock Inc., the world’s largest money manager, said the securities were “most vulnerable to a rise in yields.” The unexpected increase in the pace of output growth shown by today’s purchasing managers’ report added to signs a strengthening economy may prompt the Bank of England to consider raising borrowing costs. While analysts predict the BOE will keep rates at 0.5 percent at a meeting next week, Governor Mark Carney has said the time to normalize them is “edging closer.”

“The latest move higher in the pound has been driven by the better-than-expected PMI,” said Manuel Oliveri, a foreign-exchange strategist at Credit Agricole SA’s corporate and investment banking unit in London. “Sterling looks to have further upside from here with more room for rising rate expectations. Improving growth conditions should be reflected in rising risks to inflation.”

The pound advanced 0.2 percent to $1.7144 at 4:30 p.m. London time after climbing to $1.7162, the highest since October 2008. The U.K currency appreciated 0.3 percent to 79.83 pence per euro as it rose versus 26 of its 31 major peers.

Rates Bets

Sterling strengthened 9.9 percent in the past 12 months, the best performer among 10 major currencies tracked by Bloomberg Correlation-Weighted Indexes, as an improving economy stoked bets the BOE would hasten an increase in borrowing costs. The euro rose 1.3 percent, while the dollar fell 3.8 percent.

With unemployment at a five-year low, house prices soaring and the economy headed for the strongest growth of any Group of Seven nation this year, investors are betting the BOE will raise the benchmark rate from the record low set in 2009 by February, Sonia derivatives contracts show.

Adding to the case for a stronger pound are the higher yields generated by declining prices for government bonds. The Debt Management Office sold 4 billion pounds of five-year gilts today at an average yield of 2.055 percent, the highest rate since April 2011. Investors bid for 1.54 times the amount of securities allotted versus 1.61 times at a previous sale on June 3.

Benchmark 10-year gilt yields climbed four basis points, or 0.04 percentage point, to 2.71 percent, exceeding today’s increases in yields on Treasuries and German bunds. The 2.25 percent bond maturing September 2023 fell 0.295, or 2.95 pounds per 1,000-pound face amount, to 96.305. Five-year rates rose five basis points to 2.08 percent.

Money Markets

Implied yields on short-sterling futures contracts expiring in March 2015 rose three basis points to 1.12 percent, suggesting traders were adding to bets on higher borrowing costs.

“We are going to see a lot more volatility in the gilts market,” Stephen Cohen, BlackRock’s chief investment strategist for international fixed income, said at a media briefing in London today. “That’s partly what the BOE in some respects is trying to do, trying to introduce a bit more volatility into the market and remove any exact pricing given the uncertainties that are out there, which makes gilts still in our view the most vulnerable to a rise in yields.”

The PMI for manufacturing rose to 57.5 in June from 57 a month earlier, Markit Economics said. Analysts forecast a decline to 56.8, based on the median estimate in a Bloomberg News survey. A gauge of new orders increased to 61.1 from 59.5, also a seven-month high.

Gilts returned 3.4 percent this year through yesterday, Bloomberg World Bond Indexes show. German securities earned 4.9 percent and Treasuries gained 3.3 percent.

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