Carney-Yellen Yield Spread Shows U.K. Trailing by Most Since '06

  • Sonia forwards show BOE rate increase not priced in until 2017
  • Pound dropped to lowest since April versus dollar after Fed

Federal Reserve Chair Janet Yellen may have raised U.S. interest rates for the first time in nearly a decade this week, but the Bank of England is going nowhere fast.

That’s the message from bond markets, where the yield difference between U.K. and U.S. two-year government securities widened to the most since July 2006 this week. With a Dec. 23 report set to confirm Britain’s economic growth cooled in the third quarter, forward contracts imply traders don’t expect a U.K. rate increase in 2016.

That view was reinforced by BOE Governor Mark Carney, who said in an interview with the Financial Times published Dec. 15 that the economic developments required to justify the first increase in U.K. benchmark borrowing costs in eight years aren’t yet in place.

The yield gap “does reflect a likely substantial lag of the BOE to the Fed,” said Marc Ostwald, a strategist at ADM Investor Services International Ltd. in London. “The risk with the U.K. is that the BOE does end up going sooner, given markets have pushed on U.K. rate expectations so heavily.”

The U.K. two-year gilt yield rose two basis points, or 0.02 percentage point, this week to 0.59 percent at the 5 p.m. close in London Friday. The 1 percent bond due in September 2017 fell 0.035, or 35 pence per 1,000-pound ($1,492) face amount, to 100.695.

Treasury two-year note yields climbed eight basis points in the same period, boosting the premium investors demand to hold the securities over their U.K. peers to 37 basis points. The spread closed at 39 basis points on Dec. 17, the day after the Fed’s announcement.

The diverging policies of the Fed and BOE are also weighing on the pound. It posted its biggest weekly drop since the period ended Nov. 6, sliding 2 percent to $1.4916 and touched $1.4865 on Dec. 17, the lowest since April 21. It depreciated 0.7 percent to 72.74 pence per euro.

Rate Outlook

Carney isn’t the only policy maker pouring cold water on speculation of liftoff in the near term. His comments came a day after BOE Deputy Governor for Markets and Banking Minouche Shafik said that wage pressures weren’t strong enough to justify an increase. A Dec. 16 report showed weekly wages excluding bonuses grew 2 percent from a year earlier, less than the 2.3 percent forecast by economists in a Bloomberg survey.

The central bank has held its key rate at a record-low 0.5 percent since March 2009 and forward contracts based on the sterling overnight index average, or Sonia, aren’t fully pricing in a quarter-point rate increase until February 2017, data compiled by Bloomberg show.

Data next week may add to pressure on the BOE to keep monetary policy loose to support the economy. Gross domestic product expanded 0.5 percent in the three months through September from the previous period, when it grew 0.7 percent, according to a Bloomberg survey of analysts.

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