By Neal Armstrong The pound fell to a two-week low against the euro after an industry report showed U.K. manufacturing shrank the most in three years in July, adding to signs Britain’s recession is deepening. Sterling dropped at least 0.4 percent against all 16 of its major counterparts after Nationwide Building Society said house prices recorded their biggest annual decline since August 2009. U.K. government bonds declined. The Bank of England announces its policy decision tomorrow after increasing its bond-purchase program in July. “The U.K. economy is in a pretty sad state and it makes you wonder why anybody should buy the pound,� said John Hardy, head of foreign-exchange strategy at Saxo Capital Markets in London. “There is a deteriorating picture for the currency based on fundamentals.� The pound depreciated 0.5 percent to 78.84 pence per euro at 3:29 p.m. London time after falling to 78.94 pence, the weakest level since July 13. The U.K. currency dropped 0.5 percent to $1.5603. A gauge of U.K. factory output declined to 45.4 last month from a revised 48.4 in June, Markit Economics said. The reading was weaker than any of the 30 forecasts in a Bloomberg survey. House prices fell 2.6 percent in July from a year earlier, the most since August 2009, Nationwide said in an e-mailed report. The pound has fallen 1.2 percent in the past three months, the fourth-worst performer of the 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The dollar gained 3.1 percent, and the euro dropped 5 percent. Moving Average Sterling’s break below so-called support at 78.80 may pave the way for a decline toward its 55-day moving average currently at 79.80 pence, according to Michael Hewson, analyst at CMC Markets in London. The yield on the 10-year gilt climbed seven basis points, or 0.07 percentage point, to 1.54 percent. The 4 percent bond maturing in March 2022, dropped 0.75, or 7.50 pounds per 1,000- pound face amount, to 121.825. U.K. government debt returned 15 percent in the past year, according to data provided by Bloomberg and the European Federation of Financial Analysts Societies. German bunds gained 11 percent, and U.S. Treasuries rose 8.5 percent. Inflation Outlook The difference in yield between 10-year gilts and similar- maturity inflation-protected securities, a gauge of the outlook for consumer prices known as the break-even rate, shrank to the narrowest in two weeks after an industry report showed shop- price inflation slowed in July. The yield gap contracted to as little as 2.32 percentage points, the least since July 17. The spread has averaged 2.81 percentage points in the past five years. Retail prices rose 1 percent from a year earlier, after gaining 1.1 percent in June, the British Retail Consortium and Nielsen Co. said. That’s the smallest gain since November 2009. Declining inflation expectations may give the Bank of England more room to introduce additional monetary stimulus to spur growth. Morgan Stanley (MS) changed its forecast for U.K. stimulus and now sees policy makers expanding their bond-purchase plan by 100 billion pounds by the end of March and cutting the key interest rate by year-end. The central bank will increase so-called quantitative easing by 50 billion pounds in both November and February, and lower its benchmark rate to 0.25 percent from 0.5 percent in November, London-based economists Melanie Baker and Jonathan Ashworth wrote in an e-mailed note to clients in London. The Bank of England will keep its bond-buying program on hold at 375 billion pounds and leave interest rates at a record low 0.5 percent tomorrow, according to a Bloomberg survey. To contact the reporter on this story: Neal Armstrong in London at narmstrong8@bloomberg.net To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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