Pound Rallies to 3-Month High as Construction Data Boosts Rate-Rise Bets

By Garth Theunissen - Feb 2, 2011 8:05 PM GMT+0800

The pound rallied to a three-month high against the dollar after a report showed the U.K. construction sector returned to growth, adding to speculation the Bank of England will have room to raise interest rates.

Sterling appreciated against all but one of its 16 most actively traded peers and two-year gilt yields climbed to the highest level since June 2009. A gauge of building activity based on a purchasing managers’ survey rose to 53.7 in January from 49.1 the previous month, Markit Economics Ltd. and the Chartered Institute of Purchasing and Supply said. That was higher than the 49.5 estimate in a Bloomberg survey and above 50, which indicates an expansion.

“The market is still focused on rate-hike expectations so a strong number will give some momentum to calls for higher interest rates,” said Chris Walker, a foreign-exchange strategist at UBS AG in London. “That provides some upside for cable.”

The pound advanced as much as 0.6 percent to $1.6230, the strongest level since Nov. 5 and the third straight day of gains, before trading at $1.6214 as of 11:47 a.m. in London. Britain’s currency gained 0.5 percent to 85.22 pence per euro.

Market speculation has intensified that the Bank of England will be forced to raise interest rates this year to quell inflation that has exceeded its 2 percent limit for more than a year, reaching an eight-month high of 3.7 percent in December. Monetary Policy Committee member Martin Weale joined Andrew Sentance in voting for a rate increase at the group’s Jan. 13 meeting on concern that inflation may become entrenched.

Sterling Futures

Short-sterling futures slumped, pushing up the implied yield on the contract expiring in December by six basis points to 1.67 percent, the highest level since July. The rise in the yield, which is used to gauge central bank rate expectations, showed investors increased bets monetary policy makers will raise borrowing costs this year.

U.K. two-year government bonds fell for a third day, with the yield on the 4.5 percent gilt due March 2013 rising 6 basis points to 1.45 percent. The security fell 0.13, or 1.3 pounds per 1,000-pound ($1,611) face amount, to 106.25.

Two-year yields earlier climbed as high as 1.47 percent, the highest since June 2009, according to Bloomberg generic prices. Ten-year yields were little changed at 3.71 percent.

Stiglitz Comment

Calls for higher U.K. interest rates may be tempered by government spending cuts, the largest since World War II, that are aimed at reducing the fiscal deficit from an estimated 10 percent of gross domestic product in the year through March to 1.9 percent by 2015. The cuts, which include the loss of 330,000 public-sector jobs and reduced investment, show the government is pursuing “excessive austerity,” Nobel Prize-winning economist Joseph Stiglitz said at a conference in Moscow today.

Central Bank Governor Mervyn King last week dismissed accelerating inflation as temporary, saying the government’s spending cuts and slowing economic growth would curb price pressures. A Jan. 25 report showed the U.K. economy unexpectedly shrank by 0.5 percent in the fourth quarter.

The U.K. 10-year breakeven rate, a market indicator of investors’ inflation expectations derived from the yield gap between nominal and index-linked bonds, was unchanged at 3.21 percent, the highest level since Jan. 12.

To contact the reporter on this story: Garth Theunissen in London gtheunissen@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net