LONDON: British government bond yields plunged on Thursday after the Bank of England raised interest rates for the first time since 2007 but signalled only a "very gradual" rise in borrowing costs over the next three years.
The BoE's decision to hike the Bank Rate to 0.5 percent from 0.25 percent came as little surprise to financial markets that had put a 90 percent probability on this outcome.
But the central bank's cautious approach to future rate rises caught investors off-guard. Governor Mark Carney - who had long warned markets were too sanguine about the prospect of higher rates - now said the BoE was on the same page as investors in "broad brush" terms.
At 1621 GMT the five-year gilt yield was down 10 basis points on the day at 0.705 percent, on track for its biggest daily slump since Aug. 4 last year - the day the BoE cut rates after June's Brexit vote.
Sterling fell also more than 1 percent while Britain's main FTSE 100 stock index jumped after the BoE decision.
Yields across the range of maturities fell heavily, although the declines were most acute for shorter-dated bonds, which are most sensitive to changes in interest rate expectations.
Short sterling futures soared by around 10 ticks across the 2018 and 2019 contracts, indicating investors were expecting a much shallower pace of future BoE rate hikes.
RBC analysts Sam Hill and Vatsala Datta said overnight index swaps suggested there was a roughly 20 percent chance of a further 25-basis-point rate hike by the BoE in February, compared with around 50 percent before Thursday's rate hike.
"Equally, the next rate hike is now priced in by November 2018," they said in a note.
"After all, for now, the (BoE's) message is still that more tightening is needed overall, but it now seems clearer that the committee will tread very carefully. Our forecast remains that there won't be a further hike in 2018."
The 10-year gilt yield was down 8 basis points on the day at 1.26 percent as of 1621 GMT, on track for its biggest daily drop since the BoE meeting of Aug. 3 this year.
The yield spread between the 10-year gilt and the equivalent German Bund contracted around 7 basis points and last stood at 89 bps.
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