LONDON: Gilt yields look set to rise further after the Bank of England backed up market bets on a rate hike around the turn of the year, but how high depends on Britain's election in May and the Greek crisis, among other factors.
A plunge in inflation helped to push yields on 10-year British government bonds to a record low below 1.34 percent in January.
But they have rebounded almost 40 basis points so far in February, boosted by signs of robust growth in Britain's economy and stabilising oil prices.
Thursday's upbeat BoE forecasts supported a shift in market expectations for the timing of the first rate rise since 2007. Having pointed as recently as two weeks ago to an initial hike in mid-2016, markets now price in February 2016. Gilt yields will likely continue to rise as the year progresses, according to ADM Investor Services strategist Marc Ostwald, and the record low yields seen in mid to late January will probably represent this year's trough. "How high we can go is really contingent on so many different potential bana
na skins, be that related to the euro zone, US monetary policy, or the domestic political situation," said Ostwald.
RBS strategist Simon Peck said the 10-year gilt yield could hit 2 percent by the end of the year, and he predicted the premium this bond offers over the 10-year German Bund will rise to new record highs. An indecisive result in the May 7 national election is the biggest threat to Britain's economic recovery, according to a Reuters poll of economists earlier this week.
Opinion polls suggest it will be a close-run affair. Most have shown the opposition Labour party either slightly ahead of, or neck-and-neck with, Prime Minister David Cameron's right-leaning Conservatives.
Gilt prices have been boosted by investors switching out of much lower-yielding euro zone government bonds and into higher-yielding British debt, especially as the European Central Bank embarks on a euro zone bond buying programme.
Growing uncertainty about Greece's place in the euro zone has added to gilts' allure as a safe-haven asset.
Ostwald said this positioning could unwind, pushing British yields higher, if Greece negotiates a new rescue deal. Greece on Friday promised to do "whatever we can" to secure a deal with its international creditors next week.
A US official interest rate hike in June -- as economists expect -- would also drive gilt yields higher, setting the stage for the BoE to follow with a hike of its own. Morgan Stanley strategist Anthony O'Brien warned the BoE could hike rates earlier than investors expect.
The BoE lowered its estimate of slack in Britain's economy sharply on Thursday and it does not plan to wait for it to hit zero before hiking rates.
"Given the recent trajectory of the reduction in slack, the first Bank Rate hike may actually be in 2015," O'Brien said.
Gilt prices fell modestly on Friday after strong German economic growth figures put pressure on safe-haven government debt and pushed stock markets higher.
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