The pound rallied against the dollar and euro after a report showed U.K. retail sales rose last month by almost four times the amount predicted by economists, adding to signs the Bank of England has room to raise interest rates. Sterling advanced against a basket of nine developed-nation peers, according to Bloomberg Correlation-Weighted Currency Indexes, while gilts fell amid speculation the central bank will be forced to raise interest rates to curb inflation. Retail sales rose 1.9 percent in January, compared with a revised drop of 1.4 percent the previous month, the Office for National Statistics said today in London. The gain was the biggest since February 2010 and exceeded the 0.5 percent median forecast of 22 economists surveyed by Bloomberg. “It seems inevitable that rates will need to go up in the next two quarters; the retail data adds to that argument,” said Chris Huddleston, a trader at Investec Bank Plc in London. “The market is moving to price in further gains in sterling.” The pound strengthened 0.6 percent versus the euro to 83.68 pence at 10:14 a.m. in London and rose 0.2 percent to $1.6202. The yield on the 10-year gilt rose two basis points to 3.78 percent, while two-year note yields, typically more sensitive to interest-rate expectations, increased five basis points to 1.51 percent. Pressure on the Bank of England to raise its benchmark interest rate from a record low of 0.5 percent increased this week after a Feb. 15 report showed inflation accelerated to double the central bank’s 2 percent target. Consumer-price growth accelerated to 4 percent in January, forcing central bank Governor Mervyn King to write a fifth letter to the Chancellor of the Exchequer to explain the monetary policy stance. Hawkish Support Sterling surged yesterday after policy maker Andrew Sentance said in a speech in London that the central bank should raise rates to boost the pound as a means of curbing inflation. King dismissed the spurt in inflation in his letter to Osborne, saying raising rates quickly would hurt the economy, which unexpectedly shrank by 0.5 percent in the fourth quarter. “There is a feeling in the market that the hawkish camp is trying to get more support and that King’s argument, that inflation will be temporary, is losing more and more appeal,” said Ulrich Leuchtmann, head of foreign-exchange strategy in Frankfurt at Commerzbank AG. “There are good arguments for joining the hawks on the MPC. The risk is that when inflation is so high above your target, it risks causing second round effects that can push inflation higher on a more permanent basis.” Money markets signal the Bank of England may boost its bank rate by about 75 basis points by year-end, according to the Sterling Overnight Interbank Average, or Sonia, Tullett Prebon Plc data shows. The implied yield on the December short-sterling futures contract rose six basis points to 1.72 percent, indicating traders raised bets that borrowing costs will rise. The U.K. 10-year breakeven rate, an indication of investors’ inflation expectations over the life of the securities, derived from the yield gap between conventional and index-linked bonds, was little changed at 3.18 percent. 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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