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Pound heads for biggest two-day drop since July

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Public borrowing surges in headache for finance minister

Reeves

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UK bond yields up after Bank of England debt sales tweaks

(Updates with comment, refreshes prices)

By Amanda Cooper

LONDON, Sept 19 (Reuters) - The pound headed for its

biggest two-day drop since late July on Friday, while bond

yields rose, after a surge in UK public borrowing and a Bank of

England rate decision that laid bare the challenge for

policymakers in balancing growth and inflation.

Official data on Friday showed public sector borrowing

between April and August totalled 83.8 billion pounds ($113.39

billion), 11.4 billion pounds more than forecast by the Office

for Budget Responsibility earlier this year.

The surge compounds the problem finance minister Rachel

Reeves faces with her November budget, in which she had already

been expected to announce new tax rises to stay on track to meet

her fiscal rules and avoid unsettling financial markets.

"The pound has sunk on this data, and is testing support at

$1.35, it is the second-worst performing currency in the G10 FX

space today," XTB research director Kathleen Brooks said.

Sterling fell 0.5% to $1.349. It has lost almost

1.1% in the last two days alone, the largest such decline since

July 31.

The BoE left interest rates unchanged on Thursday as

expected and opted to reduce the pace of its government bond

sales to minimise the impact on the more volatile longer-dated

section of the market.

With inflation running at nearly double the central bank's

2% target, the BoE has only limited scope to lower rates much

more to help shore up the economy, where evidence is mounting of

weakness in the labour market.

UK bond yields rose on Friday, with long-dated 30-year gilts

up 4.3 basis points at 5.547%, pushing the premium

over long-term borrowing costs in the United States to the

highest in three years.

"A combination of gilt market stress and reversals on

welfare reform has used up the thin margin for error in the

government's current spending plans, meaning taxes will almost

certainly need to rise if the fiscal rules are to be met," Matt

Swannell, who is chief economic advisor to the EY ITEM Club,

said.

Data on Friday showed retail sales rose by more than

expected in August, thanks to sunny weather, although sales

growth in July was revised down.

Yet this offered little comfort to bruised UK bonds or the

currency.

A number of major retailers, including Primark owner

Associated British Foods ( ASBFF ) and budget supermarket Aldi UK,

have signalled concern about the outlook for consumer spending

given upcoming tax rises and a deteriorating jobs market.

"This is yet another disappointing piece of economic news

which will add to Chancellor Rachel Reeves's woes. But as we saw

yesterday, the Bank of England dare not cut rates given that

inflation is nearly double the official target of 2%, and likely

to rise further," Trade Nation senior market analyst David

Morrison said.