Short-dated gilts surge as Fed prompts UK rate hike rethink

LONDON: Short and medium-term British government bond prices rose on Thursday as expectations that British interest rates will rise early next year were scaled back following dovish minutes from the U.S. Federal Reserve and a downbeat business survey.

Bond prices rose globally after the minutes showed Fed policymakers were worried about the global economy and the strength of the dollar.

Coupled with a British Chambers of Commerce (BCC) business survey that warned of a "first alarm bell" for Britain's rapid recovery, gilt yields fell heavily - particularly across the two to 10-year maturities.

Short sterling <0#FSS:> futures rose strongly across 2015 contracts and further out, suggesting the markets had pushed out expectations for British interest rate rises in the future.

"The more you push the Fed timeline (for future interest rate hikes) out, the more you push the Bank of England timeline out," said Marc Ostwald, strategist at ADM Investor Services.

Asked where the market was pricing the next BoE rate hike, Ostwald said: "We're on February still, but we're leaning more and more towards June, and maybe it'll even be after that."

He added that the BCC survey, which showed firms reported the weakest export growth in two years, was a worrying sign for Britain's economic recovery, and therefore also coloured the view that BoE rates will rise in the next few months.

The BoE announces its October monetary policy decision at 1100 GMT, and economists polled by Reuters expect no change to record low interest rates of 0.5 percent.

Five-year gilts outperformed other maturities, with their yield dropping some 6 basis points on the day to 1.54 percent at 0931 GMT. The yield had earlier bottomed out at 1.505 percent - its lowest since Nov. 26 last year.

The 10-year gilt yield earlier hit a fresh 16-month low at 2.191 percent, and was last at 2.23 percent - down more than 3 basis points on the day.

The yield spread between 10-year gilts and the equivalent German Bund tightened further on Thursday to hit a session low of 131.5 basis points, the narrowest gap since mid-June. It was last at 134.5 basis points, down around 1 basis point on the day.