UK gilt yields fall to 7-week low after inflation surprise

LONDON, July 18 (Reuters) - British government bond yields fell to a seven-week low on Wednesday after weaker-than-forecast inflation data dented expectations that the Bank of England will raise interest rates on Aug. 2.

Ten-year yields dropped more than 5 basis points to hit a low of 1.211 percent last seen on May 30, after official data showed that consumer price inflation held steady at 2.4 percent in June -- in contrast to forecasts in a Reuters poll for a rise to 2.6 percent.

Five-year yields fell a similar amount to 0.970 percent, their lowest since June 1, while two-year yields hit a two-week low of 0.706 percent.

"The downside surprise to today's inflation figures has cast uncertainty on the likelihood of the Bank of England hiking base rates in August," economist Dean Turner at UBS Wealth Management said.

A Reuters poll published on Tuesday showed that 47 out of 75 economists expected the BoE (Shenzhen: 000725.SZ - news) to raise its main interest rate to 0.75 percent from 0.5 percent on Aug. 2, little changed from a month earlier.

But after Wednesday's data, one measure of market interest rate expectations based on overnight interest rates swaps fell to around 70 percent from close to 80 percent before.

Short sterling interest rate futures for the next couple of years rose by 3-5 ticks, again showing a reduced pace of future rate rises.

Ten-year gilts also outperformed against benchmark German debt on the softer inflation numbers, with the yield spread between the two tightening by 3 basis points to a six-week low of 87.5 basis points.

A BoE rate increase next month would be only its second since the 2008 global financial crisis.

The central bank has said it expects rates will need to rise at a gradual and limited pace over the coming years to keep inflation in check while it sees a growing risk of domestic price pressures keeping inflation above its 2 percent target.

Sept long gilt future 123.76 (+0.44)

Sept 2018 short sterling 99.18 (+0.15)

Dec (Shanghai: 600875.SS - news) 2018 short sterling 99.14 (+0.02)

10-year gilt yield 1.22 pct (-4.4 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. Treasuries Debt reports --------------------GILT STRIPS DATA ------------------------- Gilt strips data All gilt strips Gilt strips IO Gilt strips PO (Reporting by David Milliken; Editing by Toby Chopra)