UK gilts suffer biggest fall in over a year as markets rethink BoE bets
By David Milliken
LONDON (Reuters) - British government bond prices suffered their biggest fall in over a year on Thursday, erasing almost all of Wednesday's strong gains, as traders rethought their view that the Bank of England would not raise interest rates next year.
On another dramatic day in financial markets on both sides of the Atlantic, 10-year British gilt yields rose more than 13 basis points on the day to 2.09 percent -- their largest one-day rise in over a year.
That followed Wednesday's slump of over 17 basis points, a fall last seen nearly two years ago as investors worldwide worried about Europe's weak economies, which might dissuade the U.S. and British central banks from raising interest rates.
"The market is saying enough is enough, and you cannot justify (Wednesday’s pricing) given the economic outlook for the UK specifically, as the recovery is well underway," said Jamie Searle, fixed income strategist at Citi.
British government bonds heavily underperformed U.S. Treasuries on Thursday, in what Searle said was an unusual move after closely tracking U.S. debt for days.
Ten-year gilts yielded 11 basis points less than Treasuries around 1600 GMT on Wednesday. Twenty-four hours later, they were yielding just 6 basis points less. Gilts also showed a similar 5 basis-point underperformance versus German Bunds .
Markets on Wednesday had all but ruled out any increase in interest rates by the Bank of England next year but on Thursday investors reassessed that view, with a rate rise priced in for the last three months of 2015.
December 2015 short sterling interest rate futures - the most heavily traded contract - settled 13 ticks down on the day, completely retracing Wednesday's move.
BoE policymaker Martin Weale - who voted for rate rises in August and September - said in a speech after British markets closed on Wednesday that the central bank should look through temporary weakness in inflation when setting rates.
While he would take account of the global and euro zone economic outlook, he said that Britain's economy had little spare capacity and that rapidly falling unemployment was a likely harbinger of inflation pressures to come.
A Reuters poll published on Thursday showed that most economists still expected the central bank to raise interest rates in the first three months of next year.
BoE chief economist Andy Haldane is expected to set out his views on the outlook for policy in a speech to be published at 0645 GMT on Friday.
Searle at Citi said that given recent volatility it would take more than one day's trading to see whether the rally in gilts had truly come to an end - a view shared by RBS strategist Simon Peck, who earlier on Thursday described trying to time the top of the gilt market as "like catching a falling knife".
Both Searle and Peck said there could still be investors looking to sell portfolios of risky assets and move their money into gilts, which would put renewed downward pressure on yields.
There was solid demand for British 10-year index-linked debt at an auction of 1.4 billion pounds of the 0.125 percent 2024 gilt on Thursday, in contrast to a more turbulent debt sale in Spain which failed to meet its target.
The 2024 linker attracted a bid-to-cover ratio of 1.95 -- down from 2.72 when it was last sold three months ago in more placid market conditions -- and offered a real yield of just -0.707 percent.
"The UK linker auction went off relatively smoothly. Break-evens were incredibly cheap. The market started selling off at the get-go in the morning, which helped," Searle said.
A greater challenge for the market is likely to come next week when Britain is scheduled to sell several billion pounds of the ultra-long 2068 gilt via syndication.
(Editing by Dominic Evans and Susan Fenton)
