Pound weakens, gilts rally as bets for a 2018 rate increase fade

Bloomberg.- The pound reversed gains and U.K. government bonds rallied after the Bank of England left interest rates unchanged and signaled it was in no hurry to tighten policy further.

Investors in U.K. money markets priced out the possibility of a rate increase this year after the central bank said that “only limited tightening” was needed in the coming years. The market-implied probability of a 25-basis-point hike, which was fully factored in for November before the BOE decision, has declined to 85 percent following the announcement.

The BOE is “acknowledging first-quarter weakness, still optimistic of a rebound but a bit more cautiously so than before,” said John Wraith, head of U.K. macro rates strategy at UBS Group AG. The central bank is “not seeming keen to fight too hard for a hawkish tone for now. Their confidence sounds shaken.”

The pound traded 0.2 percent lower at $1.3526 as of 1:50 p.m. London time, while the yield on 10-year gilts fell four basis points to 1.42 percent.

BOE Governor Mark Carney fielded several questions from reporters on the reliability of the bank’s guidance during the press conference following the decision, after a roller-coaster month which saw markets go from almost fully pricing a May rate hike to discounting it.

Money markets now fully price a rate increase in February 2019, while pound analysts say the central bank’s cautious stance is seen returning the market focus to trends in economic data.

“There is nothing in what Carney said that pushes back against an August move, though the inflation report is less dogmatic,” said Jane Foley, head of currency strategy at Rabobank. “What is very clear is that the Bank has offered a reassurance that it is still data dependent, not model dependent as was feared in February. The pound will have to revert to watching data.”

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