As the Federal Reserve prepares to raise interest rates, bond investors see the Bank of England lagging ever further behind on tightening policy.
Two-year Treasury yields rose this week to the highest compared with U.K. securities since June. That coincided with an increase in the gap between when traders expect the two central banks to raise interest rates, a Morgan Stanley index shows.
“That spread can test the highs seen earlier this year,” said Vatsala Datta, a rates strategist at Royal Bank of Canada in London. “U.S. hikes will be quicker than the U.K. just because the U.S. is a stronger economy and also less open overall, while in the U.K. there are more spillover risks from Europe.”
Investors will be searching for clues about the timing of the Fed’s liftoff when the central bank publishes the minutes of its July policy meeting later Wednesday. Traders price in a 50 percent chance of a move in September.
The yield on two-year gilts tumbled four basis points, or 0.04 percentage point, to 0.55 percent as of 5 p.m. London time on Wednesday. The 1.75 percent security due January 2017 rose 0.055, or 55 pence per 1,000-pound ($1,564) face amount, to 101.70.
The U.S. yield dropped two basis points to 0.71 percent. The gap between the two yields was 16 basis points, about level with their peak on Aug. 17. That’s compared with as high as 27 in February. Gilt yields were higher than their American counterparts for most of 2013 and 2014.
Britain’s government bonds fell and the pound strengthened on Tuesday after inflation unexpectedly accelerated last month. Even so, with the annual rate at only 0.1 percent, the BOE’s Monetary Policy Committee has been reluctant to raise rates.
Forward contracts based on the sterling overnight index average, or Sonia, signal a 25 basis-point increase to the BOE’s 0.5 percent main rate in August 2016.
“Given the low inflation outlook, and the fact near-term inflation risks are still very much on the downside, plus the ongoing uncertain external environment, there’s no rush for the MPC to hike,” said Daniela Russell, a rates strategist at Credit Suisse Group AG in London.