Sterling, gilt yields tumble

Sterling extended losses against the dollar and euro on Tuesday while British government bond yields tumbled to 2-1/2-year lows as money markets raised their bets on a Bank of England interest rate cut in the coming year. Money markets that had assigned a roughly 40% probability to a December 2019 rate cut, raised this to 57% after a speech by BoE Governor Mark Carney who flagged uncertainties stemming from trade disputes and Britain's departure from the European Union.
Over the next 12 months, they see a more than 80% chance of a 25 basis-point rate cut. While Carney stuck to his line that the central bank could raise rates in event of a smooth Brexit, he noted growing risks from the US-China trade spat and admitted investors were pricing in a rate cut. In "some jurisdictions" a policy response may be warranted as insurance, Carney said, in an apparent reference to the United States. Following other major central banks, the BoE "is turning more dovish," said Lee Hardman, currency analyst at MUFG.
"The markets have become more confident again at pricing in a rate cut ... reinforcing the pound's downward momentum," Hardman said. Yields on 10-year British government bonds or gilts fell more than 8 basis points to 0.73% and were set for their biggest one-day fall in absolute terms since March. This would be the first time in a decade the 10-year yield is below the BOE's main policy rate, according to Tradeweb.
By 1530 GMT, the pound was down 0.4% at $1.2584, a new two-week low. Against the euro, it fell 0.5% to 89.66 pence. The currency weakened after PMI data showed June was the British construction sector's worst month since 2009. Together with Monday's gloomy manufacturing PMI release, it boosted investors' expectations of BoE interest rate cuts. "People have already baked in pretty weak expectations" on the UK economy and recent mixed data "makes it quite difficult to try and judge underlying growth," said Paul Hollingsworth, London-based UK economist at BNP Paribas.
The British currency has lost about 0.9% of its value against the dollar over the past week. Investors are also concerned about who will be the next prime minister and whether the new leader will be able to strike a Brexit transition deal with the European Union before an October 31 deadline for the country's departure from the bloc.
"Markets have been focused more on politics than the economy," Hollingsworth said. These concerns have made investors reluctant to take big positions in the pound, with both hedge funds and real money investors broadly short on the currency, data from the Commodity Futures Trading Commission (CFTC) shows.