U.K. Gilts Slide on Global Stock Gains, Bank of England Minutes

By Agnes Lovasz

July 23 (Bloomberg) -- U.K. bonds fell as stocks worldwide rose and central bank minutes showed a policy maker voted for the first time in a year to increase interest rates to curb accelerating inflation. The pound jumped.

The yield on the 10-year gilt climbed to the highest level since July 3 as the Dow Jones Stoxx 600 Index, a European equity benchmark, rose as much as 2.1 percent. Asian stocks and U.S. index futures also gained. Bank of England policy maker Timothy Besley, who voted to lift rates at this month's meeting, said the fastest inflation in a decade put the bank's credibility at risk.

``Equities are having a reasonable bounce, which erodes the risk premium in the market,'' said Jason Simpson, a fixed-income strategist in London at Royal Bank of Scotland Group Plc. ``The negative risk hanging out there is that some policy makers may say, given where inflation is going, we need to hike rates.''

The yield on the 10-year gilt climbed 6 basis points to 5.06 percent at 1:12 p.m. in London. The price of the 5 percent security due March 2018 declined 0.45, or 4.5 pounds per 1,000 pound ($2,000) face amount, to 99.56. The two-year note yield advanced 8 basis points to 5.12 percent, after sliding 7 basis points yesterday. Yields move inversely to bond prices.

The pound climbed against all 16 of its major counterparts. Against the euro, the currency rose to 78.70 pence, from 79.24 pence yesterday. It was at $2.0005, from $1.9917. The pound has dropped 6.6 percent versus the euro this year and gained 0.8 percent against the dollar.

Rates Unchanged

Bank of England policy makers left rates unchanged at 5 percent on July 10 after lowering them three times since November in a bid to stave off a recession.

The implied yield on the December short-sterling futures contract advanced 10 basis points to 5.97 percent, showing traders increased wagers borrowing costs will increase.

Central bank policy maker Andrew Sentance said July 17 he was ``particularly struck'' by the jump in inflation and considered voting for higher rates last month. David Blanchflower, who favored a reduction at the last meeting, said the economy was likely to ``contract sharply in the near term, possibly for several quarters.''

``The minutes are tilting the expectations on the hawkish side,'' said Peter Schaffrik, a fixed-income strategist in London at Dresdner Kleinwort. ``The bank is deemed to be `laissez faire' when it comes to inflation, hoping the problem will go away by itself if the economy is sluggish enough and now that's brought into question. It does change the near term picture.''

Two- and 10-year gilt yields will rise to about 5.25 percent in the next three to six months, Schaffrik said.

Opposing Viewpoint

The MSCI Asia Pacific Index gained 1.5 percent and futures on the Standard & Poor's 500 Index increased 0.6 percent. The MSCI World Index, a global measure, advanced for the sixth day, climbing 0.4 percent.

Some analysts disagree.

The difference in yield, or spread, between four- and 10-year U.K. gilts will widen as the threat of a recession prompts the central bank into ``aggressive easing'' of rates, Royal Bank of Canada said.

The spread between the March 2012 and March 2018 yields will widen to as much as 22 basis points, said Richard McGuire, a senior fixed-income strategist in London at RBC. It was less than half a basis point as of 9 a.m. today. McGuire said the forecast has no specific timeframe, though he typically suggests strategies on a three-month horizon.

U.K. mortgage approvals slumped in June, the British Bankers' Association reported today. Banks granted 21,118 loans for house purchase, down 67 percent from a year earlier and the lowest since the data begin in 1997, the BBA said.

Slowing growth and the prospect of rate cuts will weaken the pound to $1.90 and to 80 pence per euro by year-end, according to the median forecast of analysts and strategists surveyed by Bloomberg. Gains in gilts will lower the yield on the 10-year note to 4.84 percent in the period, a separate survey showed.

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net