Gilts jump on Japan recession shock, weak UK inflation outlook

LONDON: British government bond prices rose sharply on Monday as Japan's unexpected return to recession caused investors to seek safe-haven assets, and top officials at the Bank of England stressed the weak outlook for British inflation.

The yield on 10-year British gilts fell as low as 2.077 percent, its lowest since Oct. 16. At 1236 GMT it was at 2.09 percent - down 3 basis points on the day.

The yield premium that 10-year gilts offer over the equivalent German Bund narrowed as investors continued to bet against a rate hike by the Bank of England until deep into 2015 or later.

"The key driver this morning is the Japanese third-quarter GDP figures," said Nick Stamenkovic, a strategist at RIA Capital in Edinburgh. "The market was positioned for a modest rebound."

Instead, Japanese gross domestic product shrank by an annualised 1.6 percent in the July-September period, after plunging 7.3 percent in the second quarter.

Investors also focused on comments from BoE Governor Mark Carney and the central bank's chief economist Andy Haldane who both spoke about the weak outlook for inflation in Britain.

Carney told The Australian newspaper that Britain was facing "huge disinflationary forces" from its trading partners, particularly in the euro zone. Haldane said in a speech he was watching "like a dove" for signs that expectations of very low inflation in Britain could become entrenched.

The BoE said last week inflation could dip below 1 percent in the next six months and was likely to hit its target of 2 percent only towards the end of its three-year outlook period.

Economists at HSBC pushed back their expectation of when the BoE would raise interest rates until the first quarter of 2016, a year later than they previously thought.

"In an environment of fragile growth and low inflation, tightening is just too frightening," Simon Wells and Liz Martins said in a report published on Monday.

Short sterling interest rate futures indicated that investors were also looking at late 2015 or early 2016 as a possible timing for the start of rate hikes by the BoE.

The biggest gains were centred on the late 2016 and early 2017 contracts saw the biggest gains, suggesting markets are now pricing in a much more gradual cycle of interest rate hikes in the years ahead.