July 30 (Bloomberg) -- The pound declined to the lowest in almost two weeks against the euro and traded near a two-month low versus the yen as the risk of holding corporate debt surged, prompting investors to unwind so-called carry trades.

The U.K. pound has fallen 3 percent versus the yen in July, the biggest monthly drop since March 2004. Worsening losses on securities backed by subprime mortgages prompted traders to pare investments in high-yielding currencies such as the pound using funds borrowed in Japan. Britain's benchmark interest rates are the highest among the Group of Seven economies.

``The fortunes of sterling will likely hinge on the news- flow on the U.S. subprime market,'' said Daragh Maher, a senior currency strategist at Calyon in London.

Against the euro, the pound fell to 67.60 pence as of 6:08 p.m. in London, from 67.37 pence on July 27. It traded at 240.07 yen, from 240.11. The pound last week had its biggest weekly decline against the yen since March.

The U.K. currency slid after Germany's IKB Deutsche Industriebank AG reported losses on U.S. subprime mortgages, pushing up a measure of risk on corporate bonds.

Contracts on 10 million euros ($13.8 million) of debt included in the iTraxx Crossover Series 7 Index of 50 European companies increased as much as 60,000 euros to 504,000 euros, according to JPMorgan Chase & Co. The CDX North American Investment-Grade Index rose as much as $22,000 to $103,000, Deutsche Bank AG prices show.

Floods, Mortgages

The pound was buoyed against the dollar on speculation the U.K.'s worst floods in 60 years will add to inflation and prompt the Bank of England to raise interest rates, while the Federal Reserve stays on hold.

U.K. banks approved more mortgages than forecast in June, a BOE report showed today, strengthening the case for higher rates. The pound was little changed at $2.0239 after earlier rising to as high as $2.0291, from $2.0242 at the end of last week.

``Inflation in the U.K. could once again move quite significantly higher,'' said Ian Stannard, a currency strategist at BNP Paribas SA in London. ``That will keep U.K. rate expectations at elevated levels. We're likely to see sterling remaining supported on the back of that.''

The Centre for Economic and Business Research yesterday said the floods could add 0.5 percent to the inflation rate this year, forcing it to quicken to a decade-high, rather than decline as forecast by the central bank.

Policy makers will raise the benchmark rate to 6 percent by year-end after holding it at 5.75 percent at their Aug. 2 meeting, according to a Bloomberg News survey of economists.

Housing Demand

Inflation could again breach the bank's 3 percent limit, forcing Governor Mervyn King to write another public letter explaining how he'll keep price growth in check, the CEBR said. King wrote the first such letter this year after inflation reached 3.1 percent in March.

Lenders granted 114,000 home loans last month, the same as in May, the BOE said today. Economists surveyed by Bloomberg had forecast a decline to 110,000. Net mortgage lending rose to the highest level in three months.

Today's figures followed a report last week that showed house-price growth slowed, and comments by BOE Deputy Governor John Gieve that benchmark borrowing costs at a six-year high are probably ``restrictive.''

U.K. bonds rose for a fourth day as risk-averse investors sought the safety of government debt. The yield on the 4 percent gilt due September 2016 fell 3 basis points to 5.16 percent. Yields move inversely to bond prices.

Traders of interest-rate futures trimmed bets the BOE will raise borrowing costs another quarter-point by year-end. The implied yield on the December contract fell 3 basis points to 6.15 percent, a 13-point drop from a week ago.

The contract settles to the three-month London inter-bank offered rate for the pound, which has averaged about 15 basis points more than the bank's key rate for the past decade.

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net

Last Updated: July 30, 2007 13:19 EDT