Pound Slides Against Dollar as Inflation Rate Falls Below Zero

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The pound dropped for a third day against the dollar as Britain’s inflation rate fell below zero for the first time in more than half a century, fueling speculation that interest rates will need to stay lower for longer.

Sterling declined against most of its 16 major peers as the prospect of central-bank rates remaining depressed and a subdued outlook for consumer prices damped demand for the currency. U.K. government bonds fell, reversing an earlier advance, while a bond-market gauge of the consumer price outlook dropped.

“It’s still a rate-differentials story and the pound is going to weaken against the dollar on that basis,” said Jane Foley, a senior currency strategist at Rabobank International in London. “While the Bank of England expects inflation to push up toward the end of the year, it did warn that it will stay close to zero or drop below zero in the near term.”

The pound weakened 0.9 percent to $1.5506 at 4:18 p.m. London time. Consumer prices fell 0.1 percent in April from a year earlier, the Office for National Statistics said on Tuesday.

“We expect inflation to be very low over the next several months,” BOE Governor Mark Carney said in interview broadcast on Tuesday by ITV. “But over the course of the year as we get toward the end, inflation should start to pick up toward our 2 percent target, and our job is to ensure that inflation remains low, stable and predictable.”

Inflation Outlook

The bond-market outlook for retail-price inflation fell after the data. The 10-year break-even rate, a measure of the prospect for inflation derived from the yield difference between gilts and index-linked securities, declined one basis point to 2.76 percentage points. That compares with an average over the past five years of 2.85 percentage points.

Investors have pushed back bets on higher U.K. interest rates and are currently not fully pricing a 25 basis-point increase until July 2016, according to MPC-dated forward Sonia fixings data provided by ICAP Plc. That assumes the current four basis-point spread for Sonia fixings below the official bank rate would return to zero once the central bank raises borrowing costs. As recently as March, a rate increase was being priced in for February 2016.

The BOE releases on Wednesday minutes of its Monetary Policy Committee’s May 7-8 meeting, at which officials kept the benchmark interest rate at a record-low 0.5 percent. The policy announcement was delayed until May 11 because of the U.K. general election.

The yield on benchmark 10-year gilts rose one basis point, or 0.01 percentage point, to 1.97 percent. The yield dropped as much as eight basis points to 1.87 percent earlier on Tuesday. The 5 percent bond due in March 2025 fell 0.015, or 1.50 pounds per 1,000-pound face amount, to 126.925.

Sterling gained versus the euro after the European Central Bank Executive Board member Benoit Coeure said on Monday policy makers will increase the pace of purchases under its quantitative-easing program in May and June.

The U.K. currency strengthened 0.7 percent to 71.77 pence per euro.

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