U.K. Bonds Halt Two-Day Gain as McCafferty Looks Past Inflation

U.K government bonds halted a two-day advance as Bank of England policy maker Ian McCafferty said slower inflation may be temporary and shouldn’t delay increases in interest rates.

Ten-year gilts fell for the first time in three days after rallying yesterday, when the prospect of a parliamentary election in Greece stoked demand for the safest assets. Inflation, now at 1.3 percent, has held below the Bank of England’s 2 percent target for 10 months. The pound rose for a third day against the dollar after a report showed the U.K.’s trade deficit narrowed in October.

“What McCafferty said reminds the market that interest rates will have to rise at one point even though that might not happen until the second half of next year,” said Marchel Alexandrovich, senior European economist at Jefferies International Ltd. “Yields also bounced back from an excessive move yesterday.”

The yield on benchmark 10-year gilt yields climbed two basis points, or 0.02 percentage point, to 1.91 percent at 4:19 p.m. London time after falling to 1.88 percent, the lowest since Dec. 1. The 2.75 percent gilt due in September 2024 declined 0.21, or 2.10 pounds per 1,000-pound ($1,569) face amount, to 107.425.

The yield on 30-year gilts was little changed at 2.65 percent after falling to 2.63 percent, the lowest since Bloomberg began collecting the data in 1996.

Rate Increase

McCafferty and fellow policy maker Martin Weale have pushed for a quarter-point increase in interest rates to address brewing inflation pressures as employment rises. Bank of England Governor Mark Carney’s majority has prevailed as the European economy deteriorated and falling oil prices eased pressure from energy costs.

Carney reiterated that any increase in borrowing costs will be gradual and limited, according to the Birmingham Post, which cited an interview.

The yield difference between two- and 30-year securities has narrowed to 213 basis points from 217 basis points a week ago as speculation the BOE is moving closer to a rate increase even with inflation subdued made longer-dated bonds more attractive relative to their shorter-dated counterparts.

The central bank will raise its benchmark base rate by 25 basis points to 0.75 percent in the second quarter of next year, according to the median of analyst estimates compiled by Bloomberg News.

Traders are less optimistic about the economic outlook than strategists. Forward contracts based on the sterling overnight interbank average, or Sonia, show traders have delayed bets for a 25 basis-point increase in the rate to beyond November. As recently as August, the market was priced for an increase in February.

Narrower Deficit

Britain’s trade deficit narrowed to 2.02 billion pounds in October from 2.8 billion pounds in the previous month, the Office for National Statistics said today.

The pound rose 0.2 percent to $1.5694 after gaining 0.6 percent in the previous two days. Sterling was 0.2 percent weaker versus the euro, at 79.15 pence.

Britain’s currency gained 4 percent this year, the best performer among 10 developed-nation currencies after the U.S. dollar, according to Bloomberg Correlation-Weighted Indexes. It strengthened 4.9 percent against the euro amid speculation that the Bank of England will raise interest rates while the European Central Bank eases policy to boost the economy.

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