- Sterling on track for biggest drop in more than a month
- Two-year gilt yields on track for biggest rise since 2022
- Investors switch from UK rate cut bets to possible hike
March 9 (Reuters) - British government bonds tumbled on Monday as a 25% jump in oil prices driven by the war in the Middle East fuelled fears of higher inflation and prompted bets on a possible Bank of England rate hike this year.
Investors see Britain as more exposed than many other European countries to an energy-price shock linked to the conflict due in part to weak government finances.
Sterling was on track for its biggest daily drop against the U.S. dollar in more than a month but later stabilised, and was last down 0.3%, while gilts again underperformed French, German and U.S. government debt.
The two-year gilt yield surged as much as 37 basis points in early trade to 4.239%. At 1351 GMT, it was up 21 bps, still heading for one of the steepest one-day rises since the turmoil after former Prime Minister Liz Truss' September 2022 fiscal plans. Bond yields move inversely to prices.
Five- and 10-year yields were up 14 bps and 10 bps respectively.
BETS SHIFT FROM RATE CUTS TO HIKE
Investors have now priced out all expectations of a BoE rate cut this year, with a quarter-point increase seen as a roughly 57% probability by December.
"With oil prices sharply higher, this will mean UK inflation is higher than expected over the short term," said Hal Cook, senior investment analyst at brokerage Hargreaves Lansdown.
"Many investors had positioned for interest rate cuts in the UK this year as this would have added to returns from gilts. Cuts now seem unlikely, so the market is repricing to reflect this."
Group of Seven finance ministers were due on Monday to discuss a potential release of emergency oil reserves.
ENERGY SHOCK RAISES PROSPECT OF COST-OF-LIVING MEASURES
On Sunday, Prime Minister Keir Starmer said supporting working people was his priority - a remark investors viewed as a possible hint of fresh measures to shield households from higher energy bills. Any new support would further strain Britain’s public finances and erode the buffer the government has to protect its fiscal rules.
Starmer said on Monday the state-regulated cap on household energy prices was set to last until June, which should give the public reassurance.
Finance minister Rachel Reeves is due to give an update on the government's economic response to the situation in the Middle East in parliament later on Monday.
Lloyds Bank said that a roughly 2.5 percentage-point rise in inflation would be enough to wipe out the government's 23.6 billion-pound ($31.4 billion) fiscal headroom, even before accounting for any new cost-of-living support or the growth hit from higher prices.
David Roberts, head of fixed income at Nedgroup Investments, said the selloff looked like it might soon be overdone and his firm had raised the share of gilts in its global fund to 9% from 6%.
"Will the Bank of England raise rates? I think it's highly unlikely if this is a short, sharp shock and oil stabilises and potentially starts to correct over the next six to eight weeks," Roberts said.
"That's something I think not just the Bank of England, but the ECB, and potentially also the Fed, can look through."
($1 = 0.7510 pounds)
Reporting by Andy Bruce. Editing by William Schomberg and Mark Potter
Source: Reuters