UK two-year gilt yields hit post-2008 high as inflation fears mount

UK two-year gilt yields hit post-2008 high as inflation fears mount

By David Milliken

LONDON, Aug 24 (Reuters) - British short-dated government bond yields surged on Wednesday, hitting fresh 14-year highs as investors worried about rocketing energy prices and the knock-on effect for inflation and Bank of England interest rates.

Two-year gilt yields GB2YT=RR leapt as much as 24 basis points on the day to 2.959%, their highest since November 2008 when Britain was in the midst of the global financial crisis. At 1550 GMT they were trading at 2.94%.

Two-year yields, which are sensitive to the BoE rate outlook, have risen more than 50 basis points since data last week showed British consumer price inflation had hit double digits sooner than expected.

Gilts have also underperformed against U.S. and German debt, as investors judge the BoE will raise rates faster than the Federal Reserve and the European Central Bank.

The yield premium two-year gilts offer over German two-year bonds EU2YT=RR rose 15 basis points on Wednesday to just over 200 basis points, its widest since August 2005.

Investors were pricing the BoE's benchmark Bank Rate peaking at 4.5% in May 2023, more than double the current 1.75%, according to rate futures.

Imogen Bachra, fixed income strategist at NatWest Markets, said Wednesday's sell-off reflected ongoing concerns about inflation - and the likelihood of more government spending to offset soaring energy bills - rather than any new triggers.

Since the BoE raised rates by half a percentage point this month, its biggest hike since 1995, policymakers appeared more focused on keeping inflation expectations in check than staving off recession, she added.

"To the extent that significantly higher gas prices drive up inflation expectations, they drive up Bank Rate expectations as well," she said.

Britain's energy regulator is due to set out new maximum tariffs on Friday that are likely to cause household bills to almost double from October, and rise further in 2023.

Whoever succeeds Boris Johnson as prime minister is likely to have to announce emergency public spending measures to offset some of the rise, leading to greater debt issuance, Bachra said.

Longer-dated gilt yields were also up sharply. Five-year yields rose 20 basis points, 10-years by 12 basis points and 30-years by 5 basis points, pushing 5- and 30-year yields to their highest levels since 2011 and 2014 respectively.
Reporting by David Milliken; Editing by Richard Chang