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Government bonds fall after BoE raises rates

January 12, 2007 | Financial Times

Government bond prices tumbled and yields jumped in the UK and the US on Thursday after the Bank of England surprised traders with a quarter-point rise in interest rates.

Short-dated gilt yields hit six-year highs as prices fell sharply after the Bank raised UK interest rates to 5.25 per cent, citing concerns over inflation pressures.

“This really stunned . . . so we saw some big, big moves at the short end of the curve. A lot of people will have got burned,” said one trader.

The yield on the two-year gilt rose 13 basis points to 5.35 per cent. The 10-year gilt yield ended the day 4.5bp higher at 4.85 per cent.

US Treasuries were also dragged lower by the decision as investors were reminded of concerns, also expressed regularly by Federal Reserve officials, that slowing growth might not mean an end to inflation.

In Europe, Bunds finished the day flat, after the European Central Bank held eurozone rates at 3.5 per cent and Jean-Claude Trichet, ECB president, made no mention of the need for “vigilance” on inflation risk.

In the US, the bearish tone in Treasuries was later compounded by a lower than expected reading of US jobless claims and weak demand for an auction of Treasury inflation-protected securities.

Initial jobless claims for the week ending January 6 were down 26,000 to 299,000, according to the Bureau of Labor Statistics, suggesting a stronger than expected jobs market. As prices fell, the yield on the benchmark 10-year US Treasury rose 4.8bp to 4.739 per cent by late afternoon. The two-year note yield was 5.1bp higher at 4.867 per cent.

Futures markets continued to reduce expectations for US rate cuts in the first half of this year. Over the past couple of weeks the implied probability of a 25bp cut in rates by June has fallen to about 30 per cent from 80 per cent.

The prices of Japanese government bonds reflected the vagaries of the stock market on Thursday.

Prices fell and yields rose to a two-month high on the 10-year in the morning, but after stocks reversed earlier gains to end down on the day, the 10-year yield also declined 2bp to 1.320 per cent.


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