Gilts surge after BoE decision, investors wary on longer term

LONDON (Reuters) - British government bond prices soared after the Bank of England signalled on Thursday that the tide was turning on high inflation and that a peak in Bank Rate was getting closer as it raised interest rates for a 10th consecutive meeting.

The 10-year gilt yield fell some 22 basis points to its lowest level since Dec. 12 at 3.075% - putting the bond on course for its biggest daily price gain since October - as investors dialled back bets that BoE policy rates will rise as high as 4.5% later this year.

Interest-rate sensitive two-year gilts also rallied a similar amount, with their yield tumbling 20 basis points to 3.22%, coming within a whisker of a two-month low.

Softening their forecasts of recession this year, the BoE's nine interest rate setters voted 7-2 to increase Bank Rate to 4.0% - its highest since 2008 - from 3.5%. The move had been expected by most investors and economists.

While gilts across the range of maturities surged as the BoE dropped its language on the need to act "forcefully" if necessary, major investors said they were cautious about the longer-term outlook for British assets, reflecting the precarious economic situation.

Earlier this week the International Monetary Fund said Britain's economy was likely to contract this year, in contrast to its Group of Seven peers.

Vivek Paul, chief UK investment strategist at the BlackRock Investment Institute, said it too believed Britain would feel more pain than its peers.

"We remain cautious on UK gilts, preferring short-term U.S. government bonds and investment-grade credit that offer some of the highest yields in the last two decades."

Theo Chapsalis, head of UK rates strategy at Morgan Stanley, said a long-term increase in net issuance by the British government meant 10-year gilts needed to cheapen by 30 basis points over the next three to five years relative to U.S. and German debt to represent good value.

Ed Hutchings, head of rates at Aviva Investors, also signalled caution around gilts.

"With the sizeable amount of gilt issuance to come, plus on-going quantitative tightening, 2023 could also be somewhat more challenging for the UK gilt market," he said.

Ahead of the BoE decision, investor bets on the peak for Bank Rate were skewed towards 4.5% by mid-2023, but by 1455 GMT most investors reckoned tightening would end with a final quarter-point increase to 4.25% in March.

(Reporting by Andy Bruce; Editing by Susan Fenton)

By Andy Bruce