The gilt market squeezed higher for most of the week even though hopes of a second interest rate cut in the UK this year were all but abandoned.
On Wednesday, the minutes of the Bank of England’s rate-setting committee revealed that only five of the nine members voted this month to cut rates – for the first time in more than two years – to 4.5 per cent.
Mervyn King, the BoE governor, voted against the rate cut, the first time a governor has been in the minority since the committee was established in 1997.
Indications that another reduction was unlikely in the near-term were a blow to the gilt market, particularly since they came a day after data showed that consumer inflation had risen much faster than expected in July, and above the Bank of England’s target of 2 per cent.
But while sell-offs ensued on each of those occasions, they were short-lived.
Yields turned higher on Friday as investors locked in profits, but over the week prices pushed higher. Two-year gilt yields fell from 4.217 per cent to 4.208 per cent, while 10-year yields went from 4.327 per cent to 4.267 per cent.
Traders covering short positions helped support prices, and the bullish sentiment in the US market also contributed to higher prices in other markets. Ten-year US Treasury yields were 4.281 per cent at the beginning of the week, but in late afternoon trading on Friday they stood at 4.211 per cent.
Some investors were, however, unwilling to bet that further UK rate cuts were completely off the cards.
“The Monetary Policy Committee stated clearly in the minutes it released this week that there is no presumption regarding the future direction of interest rates,” wrote Stephen Lewis, analyst at Monument Securities.
Many market watchers are looking to future economic data to help gauge where interest rates may go next.
“Given that the committee is expecting economic activity to strengthen, it might only take a continuation of the current run of relatively weak news for the MPC to soon start sounding more dove-ish and for market interest rate expectations to start falling back accordingly,” according to Capital Economics.
Next week’s UK data includes the CBI industrial trends survey and new information on the components of second-quarter GDP. Meanwhile, business climate reports and other German data should shed light on eurozone economic growth.
For now, few are making strong bets on the BoE’s next move. The interest rate futures contract for March 2006 is about 4.43 per cent while the June 2006 contract is 4.41 per cent.
“That clearly shows that the market does not know what is going to happen. It’s pricing nothing in at all,” said Wee-Khoon Chong, rates analyst at RBS Financial Markets.