Pound hits 2-month high versus trade basket, gilt yields soar

LONDON: Sterling hit a two-month high against a trade-weighted basket of currencies while 10-year gilt yields rose to two-year peaks after UK retail sales beat forecasts and bolstered expectations of early monetary tightening.
Investors steadily brought forward expectations of a hike in the bank rate, currently at 0.5 percent. Sterling overnight interbank average rates (SONIA)- the very short-term interest rates that form the basis of lending costs to the wider economy — are pricing in a first move in 18 months, compared with two years on Wednesday.
Currently under its “forward guidance” plan, the Bank of England expects to keep rates low until the end of 2016 when it expects the jobless rate to fall to 7 percent. But a steady improvement in data is leading to doubts whether the guidance plan can keep rates anchored for that long.
Retail sales for July rose 1.1 percent from a month earlier, easily beating expectations of a 0.6 percent rise. That comes after a string of recent releases, ranging from rising house prices to a jump in services activity and brighter prospects for the job market.
Sterling was up 0.3 percent at $1.5550, having hit$1.5595, its highest level since mid-June. The euro was down at 85.13 pence, a 1-1/2 month low, while against a trade-weighted basket, sterling was up at 81.50, a two-month high, Bank of England data showed.
“Consecutive data surprises have pushed sterling higher with the SONIA rates rising and the back-end of the gilt curve steepening,” said Adam Myers, head of European FX strategy at Credit Agricole. “Markets are wondering if the BoE forward guidance is backfiring.”
Kenneth Dickson, investment director at Standard Life, said the data was driving investors to unwind short positions.
“This has a bit more to run, especially against the euro. We expect euro/sterling to drop toward 84 pence in coming weeks.”
The 10-year gilt yield hit a two-year high of 2.713 percent and the spread over German Bunds widened to its highest in nearly three years, according to Reuters data.
The 18-month SONIA rate rose to 0.5025 percent, from 0.4900 percent before the retail sales data was released and 0.47125 on Wednesday morning.
The two-year SONIA rose to 0.5650 percent from 0.54875 percent beforehand as investors are increasingly pricing in a greater chance of a hike in 2015 by the Bank of England.
Those expectations were bolstered on Wednesday after the jobs report pointed to a brighter outlook and central bank minutes showed an unexpected division among policymakers about the guidance plan.
The steady shift in expectations has taken markets’ view of the Bank of England rate outlook back to where it was in late June, just before Mark Carney became governor. Soon after taking over on July 1, Carney dampened expectations of an early move by calling a rise in short-term money market rates “unwarranted.”
“Tighter financial conditions are the last thing the Bank wants and, as such, we believe that Carney will attempt to verbally push back market pricing over the coming weeks,” Morgan Stanley said in a morning note.