British bond premium over Bunds hit highest since 1997

The yield premium between British and German bonds reached its highest in nearly 17 years on Friday, after events this week reinforced the view that the regions are on diverging monetary policy paths. While a slew of industry surveys backed up the view that the Bank of England may raise interest rates this year, European Central Bank President Mario Draghi has kept the possibility of further monetary easing firmly on the table.
Economists in a Reuters poll still expected the first British rate hike to come early next year but gave a 40 percent chance of a hike this year compared to just 30 percent in a poll taken in early May - the last time that question was asked. "We've had strong UK data overall (this week). European PMIs are flat-lining at much lower levels than the UK, so you've had that kind of macro divergence," Andy Chaytor, strategist at Nomura said.
British manufacturing activity expanded at its fastest rate in seven months in June, construction activity grew at its fastest annual pace in four months, and activity in the services sector slowed but remained robust. In contrast, euro zone firms expanded at their slowest rate in six months in June and Draghi said on Thursday the ECB stands ready to create money in future if required.
Against this backdrop, British gilts underperformed German Bunds, driving the 10-year yield spread between the two to 149.5 basis points - its highest since 1997 and more than 3 basis points wider on the day. British bonds however were flat across maturities with the 10-year yield steady at 2.75 percent at 1252 GMT in generally subdued trading while US markets are shut for the Independence Day holiday.
Chaytor said the data this week did not ultimately change the monetary policy outlook, with markets currently pricing in a 60-70 percent chance of 25 basis point rate hike in November and fully discounting one in January. "If you are looking at one piece of data that could really alter expectations, bring them forward, then it would probably need to be wages," he added.