Britain’s strengthening economic outlook is leading traders of currencies, money markets and bonds to the same conclusion -- the Bank of England is going to need to start considering raising interest rates soon.
While that’s good news for the pound, which traded at a 16-month high versus the euro today, it’s bad news for U.K. government bonds as 10-year gilt yields rise to the most relative to German bunds since 1998. Two-year rates climbed to the highest since July 2011 today as the Confederation of British Industry added to forecasts predicting stronger growth. The central bank will present its quarterly Inflation Report, including economic forecasts, on Wednesday.
“The market has largely factored in a rate hike in the first quarter of 2015, but there is only a small probability of a move before year-end priced in,” said Nick Stamenkovic, a fixed-income strategist at broker RIA Capital Markets Ltd. in Edinburgh. “Gilts look set to remain on the defensive near-term as the BOE shifts towards normalization. The BOE looks set to upgrade its view of the U.K. economy in May’s quarterly Inflation Report.”
The Bank of England has kept its benchmark interest rate at a record-low 0.5 percent since March 2009 to aid Britain’s recovery from the global financial crisis. Now traders are betting stronger growth will lead the central bank to increase its key rate by 25 basis points by March, derivatives based on the sterling overnight interbank average show. Implied yields on short-sterling futures rose today, a sign investors were bringing forward bets on when the first rate increase may come.
The U.K.’s two-year yield climbed three basis points, or 0.03 percentage point, to 0.79 percent at 4:26 p.m. London time after reaching 0.80 percent, the highest since July 22, 2011. The 2 percent gilt maturing in January 2016 fell 0.055, or 55 pence per 1,000-pound ($1,687) face amount, to 102.035.
The 10-year yield rose five basis points to 2.73 percent, after reaching 2.74 percent, the highest since April 4. The rate was 1.27 percentage points greater than its German equivalent, the biggest gap since August 1998, based on closing prices.
The CBI said today it had increased its forecast for U.K. growth this year to 3 percent, from 2.6 percent previously. The Organisation for Economic Cooperation and Development and the National Institute of Economic and Social Research both raised their 2014 predictions last week, to 3.2 percent and 2.9 percent, respectively.
“Our central assumption is that interest rates will rise in the first quarter of 2015,” the CBI wrote in the report.
A report this week will show the U.K. unemployment rate dropped to 6.8 percent in the three months through March, a more-than five-year low, economists in a Bloomberg News survey said before the data is released on May 14.
The pound appreciated 0.2 percent to 81.53 pence per euro, and touched 81.43 pence, the strongest level since Jan. 9, 2013 as higher interest rates on gilts versus euro-area securities boosted the allure of the pound.
The 18-nation shared currency slid last week after European Central Bank President Mario Draghi told reporters that policy makers were “comfortable” with easing policy next month.
The pound climbed 0.1 percent to $1.6874. It reached $1.6996 on May 6, the highest since August 2009.
Sterling has gained 1.2 percent in the past month, the best performer among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro weakened 0.8 percent, while the dollar gained 0.2 percent.
The yield on short-sterling contracts due in March climbed four basis points to 1.05 percent today, up from this year’s low of 0.83 percent in February.
In the U.K., “we’re now thinking about when do we raise rates, because growth is predicted to be over 3 percent this year,” Richard Holmes, chief executive officer for Europe at Standard Chartered Plc, said in an interview in London with Anna Edwards on Bloomberg Television’s “Countdown.” “We think Bank of England could well look at raising rates, maybe first quarter of next year.”
Gilts returned 2.9 percent this year through May 9, according to Bloomberg World Bond Indexes. German bonds gained 3.2 percent, while Treasuries earned 2.6 percent.