UK gilts take biggest dip in 6 months as market reprices BoE bets, election risk

By David Milliken

LONDON, April 22 (Reuters) - British government bond prices took their biggest one-day tumble in six months on Wednesday as markets priced in an earlier rate rise by the Bank of England after it published its latest policy minutes.

Five- and 10-year government bond yields jumped more than 12 basis points on the day, taking yields to their highest in nearly six weeks, while interest rate futures markets brought forward by three months to May 2016 the expected timing of a first rise in BoE (Shenzhen: 000725.SZ - news) rates from their record-low 0.5 percent.

Minutes of the BoE's April policy meeting showed the central bank saw a chance that inflation could rebound faster than expected next year, and that it thought the rate tightening priced in by markets was "exceptionally slow".

Even (Taiwan OTC: 6436.TWO - news) so, the scale of Wednesday's market move was large and might also reflect previously latent concerns about an inconclusive result to Britain's May 7 election, said RBS (LSE: RBS.L - news) fixed income strategist Simon Peck.

"The only obvious catalyst is the MPC (KOSDAQ: 050540.KQ - news) minutes, which did not seem as hawkish as something that should justify an 11-12 basis point sell-off," he said. "But we have been expecting gilts to underperform and this could be what they needed to start motoring. The political backdrop provides a challenging environment for sterling assets," he added.

Central banks and others have also warned about a lack of liquidity in bond markets, which can lead to an exaggerated reaction to events.

The gilt market's reaction to the BoE minutes was initially relatively limited, but steadily increased over the day, while sterling strengthened past $1.50 to its highest in five weeks.

Ten-year gilt yields were 13 basis points up on the day at 1.70 percent at 1500 GMT, the largest rise since Oct (HKSE: 3366.HK - news) . 16 and their highest level since March 13. Five-year yields rose by a similar amount to 1.316 percent.

While prices for German Bunds and U.S. Treasuries also fell on Wednesday, gilts led the downward move. The spread in yields between 10-year gilts and Bunds widened by 8 basis points to a six-week high of 154.8 basis points. Against Treasuries, gilts underperformed by 7 basis points.

Short-sterling interest rate futures also fell sharply as markets priced in higher rates, with the most heavily traded contract, that for December 2015, dropping 5 ticks to 99.24. Contracts further into the future fell as much as 12 ticks .

Peck said gilts were at risk of further falls in the run-up to May's election, which could leave neither major political party with enough seats to form a stable government.

"We are now right on the cusp of the period when markets really focus in on prices and political risk," he said.

June long gilt future 119.52 (-1.23)

June 2015 short sterling 99.40 (UNCH)

Dec (Shanghai: 600875.SS - news) 2015 short sterling 99.24 (-0.05)

10-year yield 1.70 pct (+13 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 (Editing by Ruth Pitchford)