The pound strengthened against the euro and the yield on two-year U.K. government notes surged to a two-year high on speculation that above-target inflation may force the Bank of England to raise borrowing costs this year.
Sterling appreciated against all its 16 most actively traded peers, advancing most against the Norwegian krone. The Bank of England’s Monetary Policy Committee, led by Governor Mervyn King, will likely leave its key interest rate at a record low of 0.5 percent when it meets Feb. 10, even with the inflation rate at almost twice the 2 percent target, according to a Bloomberg survey of 62 economists.
“What has been driving the pound is expectations of higher interest rates going forward, and nothing has come out to counter that possibility,” said Neil Mellor, a London-based currency strategist at BNY Mellon. “We don’t think they’ll hike this week, but the important thing is what they say. Some MPC members are clearly becoming concerned about the impact of doing nothing about inflation.”
The pound appreciated 0.5 percent to 83.90 pence per euro at 2:20 p.m. in London, the first breach of the 84 pence level since Jan. 19. Britain’s currency was little changed versus the dollar at $1.6114, after earlier gaining as much as 0.5 percent.
Two-year notes fell for a second day, raising the yield on the 4.5 percent security due March 2013 by six basis points to 1.58 percent, after earlier rising to 1.63 percent, the highest intraday level since February 2009. The note lost 0.14, or 1.4 pound per 1,000-pound ($1,614) face amount, to 105.93.
Rate Outlook
The so-called “shadow” monetary policy committee of the Institute for Economic Affairs, a London research group, is in favor of an immediate rate increase to 1 percent by a margin of 5 to 4, the Sunday Times reported yesterday, without saying where it obtained the information.
“This is an interesting turnaround in opinion,” Credit Agricole SA said in a client note today, referring to the Sunday Times article. “One suspects the debate is drifting in the same direction at the MPC itself, but in a more subdued way.”
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. Inflation reached 3.7 percent in December, equalling the reading in April, which was the highest since November 2008.
Short-sterling futures fell, raising the implied yield on the contract expiring in December by five basis points to 1.75 percent. A higher yield, which is used to gauge central bank rate expectations, indicates investors are adding to bets that policy makers will increase borrowing costs.
“We see a zero chance of the Bank of England raising rates at this meeting, but I guess some people don’t want to completely rule out that possibility given recent inflation headlines,” said Jane Foley, a senior currency strategist at Rabobank International Ltd. in London.
The U.K. 10-year breakeven rate, an indication of investors’ inflation expectations derived from the yield gap between conventional and index-linked bonds, was little changed at 3.23 percent. The rate climbed as high 3.33 percent earlier today, the highest level since September 2008.
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
