Short-dated gilt yields set for biggest monthly drop since 2010

By Andy Bruce

LONDON, Jan 29 (Reuters) - Short-dated gilt yields were on track for their biggest monthly drop since 2010 on Friday after the Bank of Japan cut a key policy rate below zero, further weakening the case for a near-term hike by the Bank of England.

British government bond prices jumped after the unexpected decision from the BOJ, which followed the European Central Bank in charging banks to park reserves.

The two-year gilt yield tipped to its lowest level in a year at 0.325 percent and was last down 7.2 basis points at 0.34 percent. That put it on track for a monthly decline of around 32 basis points, the biggest drop since February 2010.

The five-year gilt yield tumbled to its lowest since Feb. 2 at 0.890 percent, dropping more than 10 basis points and likewise on track for its biggest monthly drop since February 2010.

Short sterling futures soared, indicating markets have further pushed back expectations for the first Bank of England rate hike into late-2017 and beyond, less than a week before Governor Mark Carney is due to present forecasts showing a likely rise in medium-term inflation pressure.

The December 2016 contract, the most heavily traded, shot up 10 ticks and looked set for its biggest daily gain since Sept. 18.

"After the surprising action from the Bank of Japan, everyone is just thinking that even the more hawkish central banks are going to struggle to tighten by much anytime soon," Jamie Searle, a fixed income strategist at Citi, said.

"We are just pricing 'lower for longer' everywhere."

Some instruments have started to reflect the possibility the BoE's next move might be to ease policy, a development that Carney might try to counteract next week when he presents the BoE's quarterly economic outlook.

Prices for overnight index swaps dated for Monetary Policy Committee meeting six months in advance, provided by ICAP (LSE: IAP.L - news) , fell to their lowest level since mid-2013 - when the debate centred on whether the BoE should further stimulate the economy rather than ease policy.

Ten-year gilt yields fell 8 basis points on the day to 1.59 percent, having earlier hit their lowest level since April (LSE: 0N69.L - news) 21 at 1.559 percent.

The yield spread between 10-year British and German government bonds narrowed around 3 basis points to 124 basis points.

March long gilt future 120.13 (+0.68)

June 2016 short sterling 99.45 (+0.04)

Dec 2016 short sterling 99.43 (+0.10)

10-year gilt yield 1.59 (-8 bps)

-------------------KEY MARKET DATA--------------------------- Long Gilt futures Gilt benchmark chain Short Stg futures Cash market quotes Deposit rates Sterling cross rates UK debt speedguide -------------------KEY MARKET REPORTS-------------------------- Gilts Sterling Euro Debt Dollar U.S (Other OTC: UBGXF - news) . Treasuries Debt reports --------------------GILT STRIPS DATA ------------------------- Gilt strips data All gilt strips Gilt strips IO Gilt strips PO (editing by John Stonestreet)