Softer Brexit bets lift UK gilt yields after May defeat

By David Milliken

LONDON, Jan 16 (Reuters) - British government bond prices slid on Wednesday as investors bet that Prime Minister Theresa May's crushing Brexit defeat in parliament would force her to take a softer tack on Brexit, boosting the chance of Bank of England rate rises this year.

Ten-year gilt yields jumped by 8 basis points to their highest level since Dec (Shanghai: 600875.SS - news) . 3 at 1.341 percent, before easing to 1.32 percent by 1545 GMT.

Interest rate-sensitive two-year yields rose as much as 5 basis points to a three-month high of 0.847 percent.

Gilts' yield premium over German debt widened, with the spread at a five-year maturity increasing to its highest since Oct (Shenzhen: 000069.SZ - news) . 15 at 131.8 basis points.

May was defeated by 230 votes when she put the Brexit deal she negotiated with Brussels to a vote on Tuesday, the biggest margin of loss of any British prime minister in modern times.

Her government faced a vote of confidence later on Wednesday. Markets expect May to win and then yield to pressure to take a softer approach to Brexit -- something which has caused sterling to rally against the dollar and euro.

"If PM May wins the confidence vote tonight ... markets (are) braced for an extended period of political uncertainty, but hopeful that a worst-case scenario will be avoided," David Page of AXA Investment Managers said in a note to clients.

The default option is that Britain will leave the European Union without a deal on March 29 unless parliament agrees on an alternative or May asks Brussels to extend negotiations.

BoE Governor Mark Carney told lawmakers on Wednesday not to read too much into the market's positive short-term reaction to May's defeat on Tuesday.

Most economists expect the BoE (Shenzhen: 000725.SZ - news) to raise interest rates once or twice this year if Britain leaves the EU with an interim trade deal that would largely preserve the status quo and lift a cloud over Britain's short-term growth prospects.

Data earlier on Wednesday showed consumer price inflation fell to its lowest since January 2017 at 2.1 percent, but the BoE has said it expects it will need to raise interest rates gradually to ensure inflation stays near its 2 percent target.

(Reporting by David Milliken; Editing by Alison Williams)