Gilts Fall as Barclays, Deutsche Bank See 2014 BOE Action

U.K. 10-year government bonds fell, pushing yields toward a three-month high, as Barclays Plc analysts added to calls for an increase in Bank of England interest rates before year-end.

Britain sold six-month bills at the highest yield in 2 1/2 years after the nation’s second-biggest lender added its voice to calls from strategists at banks including Credit Suisse Group AG and Deutsche Bank AG for the BOE to act in 2014. Derivatives markets show investors are betting the Bank of England will raise interest rates twice by May. The pound held yesterday’s gain versus the euro as U.K. 10-year yields climbed to the highest relative to German bunds since 1997.

“Until people feel that there’s something which is going to derail the Bank of England from raising earlier rather than later, gilts are likely to underperform,” said Marc Ostwald, a strategist at Monument Securities Ltd. in London. “Does 2.77 percent look adequate for the prospect of the bank going by the end of the year and gradually tightening after that? It probably is in 10-year yields.”

Banks are bringing forward their estimates for when the U.K. central bank will raise interest rates after BOE Governor Mark Carney said on June 12 that the first increase “could happen sooner than markets currently expect.” Barclays previously predicted the first step would come in the second quarter of 2015, economists Philippe Gudin in Paris and Armela Mancellari in London wrote in an e-mailed note yesterday.

Yield Spread

The 10-year yield rose four basis points, or 0.04 percentage point, to 2.77 percent at 4:30 p.m. London time, after rising to 2.79 percent on June 13, the highest level since March 11. The securities pay a yield that’s 142 basis points higher than the rate on German debt of similar maturity, the widest spread since July 1997.

The 2.25 percent gilt due in September 2023 fell 0.295, or 2.95 pounds per 1,000-pound ($1,701) face amount, to 95.775.

Forward contracts based on the sterling overnight interbank average, or Sonia, show investors are betting the benchmark rate will increase 25 basis points by February, versus May before Carney’s speech last week, and a further 25 basis points to 1 percent by May. BOE officials last increased borrowing costs in July 2007.

The BOE isn’t under pressure to raise rates quickly because wage pressures and inflation pressures aren’t “tearing away,” Chief Economist Andrew Haldane said in an interview published on The Scarborough News’s website today.

Borrowing Costs

Rising short-term rates are pushing up borrowing costs for the government. The U.K. sold 3.5 billion pounds of 28-, 91-and 182-day bills today. The six-month securities were sold to yield 0.4714 percent, the highest since November 2011. Britain’s two-year borrowing costs increased four basis points to 0.92 percent.

Sterling is strengthening against the euro as rising interest rates in the U.K. offer higher returns than those that are available in mainland Europe. The pound was at 79.85 pence per euro after appreciating to 79.59 pence on June 16, the strongest since Oct. 1, 2012. It fell 0.2 percent to $1.7012 after reaching $1.7063 yesterday, the highest since Oct. 21, 2008.

The U.K. currency strengthened 8.6 percent in the past year, the best performer after the New Zealand dollar among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro gained 1 percent, while the dollar fell 2 percent.

Gilts returned 2.9 percent this year through yesterday, according to Bloomberg World Bond Indexes. Treasuries earned 2.7 percent and German securities gained 4.3 percent.

Before it's here, it's on the Bloomberg Terminal.