Energy cap, ECB rate hike push UK yields to 11-year high

By David Milliken

LONDON (Reuters) - British 10-year government bond yields rose to their highest since 2011 on Thursday, after new Prime Minister Liz Truss announced tens of billions of pounds of extra borrowing and the European Central Bank raised interest rates by a record amount.

Speculation about Truss's plan - which will see average household energy bills capped for the next two winters - had contributed on Tuesday to the biggest daily sell-off in 30-year gilts since 2020.

Truss told parliament on Thursday the cap would reduce the peak rate of inflation by 5 percentage points, but that a full estimate of its cost would have to wait until later this month when finance minister Kwasi Kwarteng gives a fiscal statement.

Last month, the BoE forecast inflation would peak above 13% in October.

Gilts showed little immediate reaction to the new prime minister's statement, but strategists said that the plan added to the difficult backdrop for British government bonds, some of which recorded its sharpest sell-off since the 1980s in August.

NatWest Markets raised its forecast for Bank of England interest rates to reach 3.5% by early next year, and increased its target for 10-year yields to 4%, citing greater government borrowing, high inflation and looming BoE bond sales.

"A regime shift is coming to the gilt market," NatWest rates strategist Imogen Bachra said.

"We think there's another leg higher to come, this time led by the back end of the curve as markets price in the perfect storm of risks to higher long-end yields in gilts," she added.

Ten-year gilt yields rose 12 basis points to their highest since July 2011 at 3.156%, and were up 9 basis points at 3.13% at 1455 GMT. Twenty and 30-year yields both hit their highest since 2014 at 3.557% and 3.500% respectively.

Most of Thursday's fall in gilt prices came after the ECB raised its key interest rates by an unprecedented 75 basis points, and in particular after ECB President Christine Lagarde said it would pay a higher rate on government deposits.

However, the sell-off in euro zone debt was concentrated in shorter maturities, whereas in Britain it was the longest maturities that fell most, reflecting their sensitivity to higher issuance.

(Reporting by David Milliken, editing by Andy Bruce and Maju Samuel)