Sterling plunges

Sterling plunged and UK stocks and government bonds rose on Thursday after the Bank of England surprised markets by voicing concern that rising gilt yields were not warranted by the state of the British economy. While the BoE kept interest rates and the extent of its bond-buying unchanged at its first policy meeting under new governor Mark Carney, markets were caught unawares by the central bank issuing a statement and signalling it could give forward guidance on interest rates next month.
Sterling slipped 1.3 percent to a low of $1.5060, its weakest since late May, and was on track for its worst daily performance since December 2011. The euro rose more than 1 percent against the pound to a 2-1/2 month high of 86.34 pence before paring gains. "The timing of the BoE statement was somewhat surprising and this could keep sterling under pressure across the board," said Valentin Marinov, head of European G10 FX strategy at Citi.
"The statement is a continuation of the dovish bias that was communicated by the previous BoE governor, Mervyn King, and his colleagues at the MPC ... they had highlighted the risks emanating from premature tightening in the financial market conditions." Ten-year gilt prices surged after the BoE announcement and yields slid 7 basis points to stand 5 bps lower on the day at 2.35 percent at 1130 GMT.
Benchmark 10-year yields rose almost a percentage point between early May and late June - an effective policy tightening. Short sterling rate futures - which reflect BoE rate expectations - were up strongly across the strip, with March 2014 contracts up 9 ticks to 99.38 and September 2015 contracts as much as 17 ticks higher. "We're seeing a big repricing of rate expectations across the market," said Shahid Ladha, gilts strategist at BNP Paribas.
Tighter monetary conditions could threaten Britain's nascent economic recovery, which seems to be taking hold in the second quarter after a recent string of positive data. Sterling's rise has also been limited against the dollar, which has been supported by expectations that the US Federal Reserve could pare back its bond-buying programme. The yield spread between 10-year US Treasuries and UK gilts moved towards recent seven-year highs in the dollar's favour.