Short-dated UK gilt yields hit 3-year highs on expectations for earlier rate hike

LONDON: Short-dated British government bond yields hit a three-year high on Tuesday on rising expectations of an earlier UK rate hike, despite tame inflation numbers.

Yields on short-dated bonds, the most sensitive to interest rate expectations, have been rising since Bank of England Governor Mark Carney said last week that a rate hike could come sooner than markets expected.

That message was reinforced by BoE policymaker David Miles who, in an interview published on Tuesday, also said markets had been underestimating the chance of a rate rise before April or May next year.

Gilt futures hit the day's highs after data showed inflation falling more sharply than forecast. However, the gains were short-lived, although they did help take the 10-year British/German yield spread off recent multi-year highs.

Consumer price inflation fell to 1.5 percent in May, its lowest since October 2009 and below a Reuters forecast of 1.7 percent.

"Gilts are still outperforming on the day ... but there were sellers into strength," one trader said. "Obviously everyone expects the (Bank of England) minutes to be hawkish tomorrow, everyone fears for some sort of rate hike this side of Christmas."

The premium 10-year British bonds offer over their German peers fell to 138 basis points, after rising to close to 141 basis points in the previous session - its highest since mid-1997.

September gilt futures were 20 ticks lower at 108.84 at 1503 GMT, pushing 10-year yields more than 2 basis points higher to 2.78 percent.

Two-year and five-year yields hit their highest since mid-2011 at 0.949 percent and 2.125 percent respectively. At 1503 GMT they were up around 2 basis points at 0.92 and 2.11 percent respectively.

The BoE releases minutes from its latest monetary policy meeting on Wednesday and investors will scour it to see whether any committee members voted for a rate hike.

"A confirmation that yes, the committee is sounding as hawkish as Mark Carney was last week ... would see some move on the back of that, even if some of it is priced in already," Victoria Clarke, economist at Investec said.