Bonds

Tuesday May 13, 11:12 AM
UK gilts lower after sharp CPI rise; European bonds up in quiet holiday trade

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LONDON (Thomson Financial) - UK gilts were lower after data showed a far sharper-than-expected rise in CPI (NYSE: CPY - news) inflation in

April, dampening hopes that the Bank of England could cut interest rates next month.

The annual rate of inflation surged to 3.0 percent in April, well above March's 2.5 percent rate and forecasts for a 2.6 percent rise. It is also just below the level at which BoE governor Mervyn King would be forced to write a letter to the Chancellor of the Exchequer Alistair Darling.

'The sharper than expected jump in UK CPI inflation... leaves inflation just 0.1 percent below letter-writing territory and places a further dent in hopes that the MPC (A050540.KQ - news) will cut interest rates again in June,' said Paul Dales, UK economist at Capital Economics.

The BoE is targeted with keeping the annual inflation rate at 2.0 percent, and King would have to write an explanation to Darling if inflation rose beyond 3.0 percent.

And with some analysts predicting that CPI could very well rise further next month, it is looking increasingly likely that King will have to write that letter soon.

The surprisingly sharp rise in the inflation data throws into stark relief the dilemma that the BoE faces as it tries to balance downside risks to the economy with the prospect of rising price pressures.

Further signs of a slowing economy emerged on Tuesday with the very weak release of the RICS house price survey for April, alongside BRC's survey which showed like-for-like retail sales fell for two months in a row for the first time in three years.

With the BoE's conflict increasing, it will now no longer be a surprise to markets why the BoE decided to leave rates on hold at 5.00 percent last week.

'Given that the Monetary Policy Committee had the consumer price inflation data last week, it is no wonder that they kept interest rates on hold,' said Howard Archer, chief UK economist at Global Insight.

Market players will now be looking to the BoE's quarterly Inflation Report on Wednesday. If the central bank projects inflation will rise still further, as economists fear it might, this will push the governor into writing a letter,and keep in place expectations that interest rates will continue to fall only gradually, with a rate cut next month looking increasingly unlikely.

'Rates will continue to fall rather slowly -- June no longer looks like such a done deal - exacerbating the economic slowdown,' said Capital Economics' Dales.

Elsewhere, European bonds were slightly higher in quiet trade amid a dearth of data, and as some market players remained away for the Pentecost holiday.

'The continuing void of economic data is once again making for exceptionally quiet trading,' said Michael Cartine, an analyst at Thomson IFR Markets.

At Yield Change on

0951 GMT pct previous close

June euribor future (Liffe) 95.21 dn 0.01

Sept euribor future (Liffe) 95.36 up 0.01

GERMANY

June bund future (Eurex) 115.18 up 0.16

4.00 pct Jan 2018 govt bond 100.03 3.99 up 0.13

FRANCE

4.25 pct Oct 2017 govt bond 98.25 4.22 up 0.01

ITALY

4.50 pct Feb 2018 govt bond 100.52 4.48 up 0.08