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The pound faltered and gilts rallied after inflation data backed up Bank of England policy maker Michael Saunders’ call for urgent stimulus to boost the U.K. economy.
Sterling weakened against the euro and 10-year government bond yields dropped to the lowest in seven weeks after the data fueled bets that the central bank will lower interest rates this year. Money markets are now fully pricing in a full 25-basis-point rate cut for May, compared to November a day ago, and see a 65% chance of a move this month.
Saunders’ view on the need for more accommodative policy comes just days after BOE Governor Mark Carney said Britain’s economic growth had slowed below potential and that the Monetary Policy Committee had discussed the merits of near-term stimulus.
“There is more room for easing expectations to rise should incoming data disappoint and that could keep short-term sterling downside risks intact,” said Manuel Oliveri, a currency strategist at Credit Agricole AG.
The pound weakened 0.2% to 85.67 pence per euro as of 4:24 p.m. in London. It dipped below the $1.30 mark earlier Wednesday before being little changed against the dollar at $1.3024. Benchmark 10-year gilt yields led a drop across Europe at eight basis points to 0.65%, having earlier dropped to 0.63%, its lowest since last November. The gap between benchmark U.K. gilt yields and their German peers reached it narrowest since mid-2018.
U.K. annual inflation came in at 1.3% for December, versus expectations for 1.5%, data showed. If the U.K. postponed easing policy this could spur risks “of a low inflation trap,” Saunders said earlier on Wednesday.
Options traders are refraining from joining the pessimism on the pound. Three-week sterling-dollar risk reversals, a gauge of options sentiment that covers the BOE’s Jan. 30 meeting, shows demand for calls and puts is almost matched. Risk-reversals in the one-month period show the least bearish sterling view since last November.
“We still think a rate cut in May is most likely in terms of timing, but the risk of an earlier move is rising,” wrote Daniela Russell, the head of U.K. rates strategy at HSBC Holdings Plc. That favors bets on the front of the yield curve flattening, she said.
(Updates chart and prices throughout)
--With assistance from Vassilis Karamanis.
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