LONDON - The pound headed for its biggest three-day drop in nearly two years on Thursday, under pressure from a sell-off in global bonds that has hit gilts especially hard, driving yields to 16-1/2-year highs, as concern mounts about Britain's finances.

Sterling was last down 0.9% at $1.226, having touched its lowest since November 2023 earlier in the day. It was set for a third consecutive daily drop, bringing losses for that period to 2%, the most since February 2023.

Against the euro, the pound was down 0.6%, around a two-month low of 83.93 pence.

Concern about rising inflation, reduced chances of a drop in interest rates, uncertainty over how the incoming U.S. administration under President-elect Donald Trump will conduct foreign or economic policy and the prospect of trillions of dollars in extra debt sales have sent bond yields soaring around the world this week.

The UK market has been hit hardest among major economies. Benchmark 10-year gilt yields have spiked by a quarter point this week alone to their highest since 2008, as confidence in Britain's fiscal outlook deteriorates.

Ordinarily, higher gilt yields would support the pound, but right now, that relationship has broken down, reflecting investors' worry about the country's finances.

"With sterling weakening, that meant growing questions were asked about whether the Bank of England could cut rates as fast as expected," Deutsche Bank strategist Jim Reid said.

"So collectively, this rise in yields is adding to the risk that the government will breach their fiscal rules and have to announce further consolidation (tax rises and/or spending cuts), whilst the weaker currency will add to inflationary pressures at the same time." 

In a statement late on Wednesday, the UK finance ministry said its commitment to the British government's fiscal rules was non-negotiable.

Sterling has been one of the best-performing currencies against the dollar in the last couple of years, largely because of the Bank of England's policy of keeping UK interest rates higher for longer than other major central banks, which creates an incentive for foreign investors to earn interest from UK assets.

Trump's proposed policies on trade tariffs and immigration carry the risk of fuelling U.S. price pressures, thereby limiting the Federal Reserve's ability to cut rates, which has sent the dollar soaring against virtually every other currency.

The derivatives market shows traders believe the Fed will deliver one rate cut this year, but are not fully pricing in the chance of a second. The UK market, meanwhile, shows almost identical expectations for the BoE.

Britain is struggling with slower growth, persistent inflation and a deteriorating labour market, lagging behind the United States, which shows resilience in virtually every area.

The premium investors demand for the extra risk of holding British 10-year government debt rather than U.S. Treasuries jumped to around 20 bps, its highest since early November.

The yield on 30-year gilts has hit its highest since 1998 this week as well, echoing the rise in long-dated yields around the world.

The last time UK debt was in the eye of the storm was September 2022, when then-Prime Minister Liz Truss unveiled budget plans that contained billions in unfunded tax cuts that sent gilts into freefall, battered the pound and forced the BoE to step to stabilise the market.

This week's move is nowhere near that of late 2022, when 10-year gilts rose a full percentage point in a week and the pound hit record lows against the dollar.

(Reporting by Amanda Cooper; Editing by Bernadette Baum)