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 two 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.” 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 $1.6169 at 5:13 p.m. in London. Britain’s currency gained 0.5 percent to 85.21 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, Bonds Short-sterling futures fell, pushing up the implied yield on the contract expiring in December by nine basis points to 1.7 percent, the highest level since July. The rise in the yield, which is used to gauge central bank rate expectations, showed investors increased bets that 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 10 basis points to 1.5 percent, the highest since June 2009, according to data compiled by Bloomberg. The security fell 0.225, or 2.25 pounds per 1,000-pound ($1,617) face amount, to 106.15. Ten-year yields rose six basis points to 3.76 percent. “We’re quite positive on sterling because we think the BOE is going to hike and that will provide support to the currency,” said Thanos Papasavvas, the London-based head of currency management at Investec Asset Management Ltd., which oversees about $70 billion. Inflation ‘Problem’ The money manager expects the central bank to raise its key interest rate twice this year to 1 percent by the end of 2011 with the first increase likely to occur “some time in the summer,” said Papasavvas. The brokerage does not make currency forecasts though it is “overweight the pound,” he added. “Inflation is going to be a problem as commodity prices continue to go up,” said Papasavvas. Oil traded near a 28-month high today, with the contract for March delivery climbing as high as $91.78 a barrel on the New York Mercantile Exchange. Crude touched $92.84 a barrel on Jan. 31, the highest intraday price since Oct. 7, 2008. 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, rose two basis points to 3.23 percent, the highest level since April last year. 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. Slowing Growth 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.’s monetary policy makers will raise the main interest rate by 25 basis points in the fourth quarter to 0.75 percent with no further action anticipated this year, according to the median estimate of economists polled by Bloomberg. 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

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