By Anna Rascouet Aug. 8 (Bloomberg) -- The pound snapped three weeks of gains against the dollar after the Bank of England said it will expand an unprecedented program of bond purchases, citing Britain’s “fragile” financial system. Gilts fell. The U.K. currency fell from its highest level this year versus the dollar after the central bank said it will extend its so-called quantitative-easing program by 50 billion pounds ($84 billion) to lower borrowing costs. The pound traded above $1.70 for the first time since October this week after reports on U.K. manufacturing, service industries and housing added to evidence that the recession is easing. “We are at a critical juncture for the pound,” said Daragh Maher, deputy head of global foreign-exchange strategy in London at Calyon, the investment-banking arm of Credit Agricole SA. “It was on the defensive after the Bank of England’s decision but the numbers were good on the week.” The pound traded at $1.6693 as of 5:34 p.m. in London yesterday, from $1.6713 at the end of last week. It traded at 84.93 pence per euro, from 85.49 pence. The yield on the two- year gilt rose 7 basis points to 1.29 percent. The 4.25 percent security due March 2011 dropped 0.17, or 1.7 pounds per 1,000- pound face amount, to 104.60. The nine-member Monetary Policy Committee, led by Governor Mervyn King, said on Aug. 6 it expects the quantitative-easing program to take another three months to complete and will be “kept under review.” The bank left the key interest rate at a record low of 0.5 percent. ‘Tipping Point’ The “BOE actions have raised the downside risks to the pound as it is likely to raise foreign-investor concerns over the BOE’s policy credibility similar to the Federal Reserve, edging the pound closer to an eventual tipping point,” Lee Hardman, a currency economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London, wrote yesterday in a report. “The U.K. needs a weak pound more than ever. In these circumstances, we believe that pound-dollar levels above $1.70 will prove unsustainable.” The pound had risen for five straight days before the central bank’s decision, advancing to $1.7043, its strongest since Oct. 21, as reports showed service industries grew more in July than economists predicted, manufacturing unexpectedly jumped in June and the Royal Institution of Chartered Surveyors reversed its forecast for house prices to decline this year. Signs of an economic recovery helped propel the pound to a 14 percent gain versus the dollar this year and a 13 percent advance against the euro. Extra 25 Billion “Household and business confidence has picked up, albeit from the very low levels experienced in the wake of the financial crisis last autumn,” the Bank of England said in a statement accompanying its Aug. 6 decision. The central bank spent 125 billion pounds since March as part of its quantitative-easing program and had permission to use as much as 150 billion pounds, about 10 percent of Britain’s gross domestic product. Chancellor of the Exchequer Alistair Darling authorized an extra 25 billion pounds, bringing the total to 175 billion pounds. The pound will rise 10 percent versus the dollar over six months, Barclays Capital said this week, raising its forecasts for the currency. Sterling will climb to $1.86 in six months and $1.88 in a year, the bank said, compared with previous estimates of $1.80 for both periods. The median analysts’ forecasts compiled by Bloomberg is for the pound to trade at $1.68 at the end of next March and the end of the first half next year. RBS Loss The British currency dropped for a second day yesterday after Royal Bank of Scotland Group Plc, the U.K.’s biggest government-controlled bank, reported a first-half loss and set aside more than $12 billion to cover bad loans. RBS Chief Executive Officer Stephen Hester said “performance over the next two years” will continue to be “poor.” “RBS shows that there are still vulnerabilities in the banking system and that works against sterling,” Calyon’s Maher said. U.K. producer prices rose in July, the Office for National Statistics said yesterday, a sign that the recession may be easing enough for companies to charge customers more. The so-called 10-year breakeven rate, a gauge of inflation expectations derived from the difference in yields on government bonds and index-linked bonds, decreased 7 basis points last week to 2.30 percentage points yesterday, the narrowest level since June 25. Gains for gilts drove the yield on the 10-year security below that of the equivalent U.S. Treasury this week for the first time since June 10. The difference in yield, or spread, was 5 basis points as of yesterday, with the gilt yielding 3.80 percent and the Treasury 3.86 percent. Gilts earned investors 1 percent this month through Aug. 6, according to Merrill Lynch & Co.’s U.K. Gilts Index. That compares with a 0.5 percent loss for German debt and a 1 percent loss for Treasuries, Merrill indexes show. To contact the reporter on this story: Anna Rascouet in London arascouet@bloomberg.net.

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