Pound Strengthens as Oil Surge Boosts Bets BOE Will Increase Interest Rate

By Garth Theunissen - Feb 28, 2011 10:02 PM GMT+0800

The pound gained against the dollar and euro as rising oil prices stoked bets the Bank of Englandwill be forced to raise interest rates this year to curb above- target inflation.

The British currency appreciated against a basket of nine developed-nation peers measured by Bloomberg Correlation- Weighted Currency Indexes. Crude traded near a 29-month high in New York after turmoil that cut Libya’s output spread to Oman, raising concern Middle East production may be disrupted further.

“Rate-hike expectations are still taking the front seat and that’s being priced into sterling,” said Chris Walker, a currency strategist at UBS AG in London. “The key theme we’re seeing right now is that currencies of countries where rate hikes are expected are being rewarded.”

The pound appreciated 0.7 percent to $1.6237 as of 1:58 p.m. in London, snapping a two-day decline. Sterling strengthened 0.1 percent to 85.22 pence per euro.

Britain’s currency advanced 1.3 percent against the dollar this month and 3.9 percent this year amid mounting pressure on the U.K.’s central bank to raise its key interest rate from a record low 0.5 percent. Consumer-price growth accelerated to 4 percent last month, a Feb. 15 report showed, the 14th consecutive month above the central bank’s 2 percent goal.

Rate-Rise Bets

“The market is betting on a rate hike in May,” said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for banks and investors.

Money markets signal policy makers will probably raise the key rate by about 67 basis points by year-end, according to the sterling overnight index average forwards, Tullett Prebon Plc data show. So-called Sonia rates indicate an increase of about 21 basis points in May.

The implied yield on the December short-sterling futures contract was at 1.59 percent compared with 1.25 percent at the beginning of the year. A higher yield indicates traders added to bets that policy makers will raise the benchmark interest rate.

Benchmark 10-year gilts rose for a sixth day, pushing yields to the lowest in a month, as political turmoil in the Middle East and North Africa boosted demand for the relative safety of the debt.

The 10-year yield fell two basis points to 3.6 percent, after earlier declining to 3.586 percent, the lowest since Jan. 25. The 4.75 percent security due March 2020 rose 0.04, or 40 pence per 1,000-pound ($1,623) face amount, to 108.70. Two- year note yields, typically more sensitive to interest-rate expectations, were one basis point lower at 1.4 percent.

‘Watch-and-Wait’

“It’s a watch-and-wait situation with the Middle East,” said Gavin Friend, a markets strategist at National Australia Bank Ltd. in London. “People still aren’t sure which way things are going to go and that’s pushing yields just a little bit lower.”

Anti-government protests have spread to Bahrain, Algeria, Morocco, Jordan, Iraq, Yemen and Oman, threatening to disrupt crude production and pushing oil prices to more than $100 a barrel in New York this month. The pro-democracy unrest in the region has already toppled the governments of Egypt and Tunisia.

The rise in gilts was due to “a classic flight to quality,” said Stamenkovic. “The concern is that what’s happening in Libya is going to spread right across the Middle East so you’re seeing more demand for safe-haven assets.”

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