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Bonds round-up: Short dated gilts soar on inflation data

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Date: Tuesday 17 Jun 2008

LONDON (ShareCast) - UK inflation reaching its highest level in 16 years failed to dampen demand for gilts, despite the possibility that the Bank of England will seek to contain inflation by increasing interest rates.

The latest report from the Office for National Statistics showed inflation soared to 3.3% in May, up from 3% in April.

“The Monetary Policy Committee remains determined to set interest rates at the level required to bring inflation back to the 2% target,” said the Bank of England governor, Mervyn King.

However, King’s letter also indicated “the path of bank rate that will be necessary to meet the 2% target is uncertain,” which some dealers interpreted as indicating the governor is not sold on the idea of a series of rate rises to contain inflation, especially as much of the inflationary pressure has been caused by a rise in fuel and food costs.

The yield on the two-year gilt slumped 20 basis points to 5.34% while the 10-year gilt’s yield fell five ticks to 5.16%.

US treasuries made headway on diminished expectations of a rate cut at next week’s meeting of the Federal Reserve’s policy makers.

Traders said the markets had gone overboard in anticipating a series of rate increases from the Fed as it grapples with the threat of inflation, and expectations now are for the Fed to leave rates unchanged next week.

This is despite worse than expected producer prices data for May which suggests inflationary pressures in the economy are building up.

The US Producer Prices Index registered its largest monthly gain since November of last year, rising 1.4% in May after April’s 0.2% advance. Pundits had been tipping a rise of 1% or just under.

The core price measurement, which excludes energy and food costs, rose 0.2% in May, in line with economists’ forecasts.

The annual rise in producer prices accelerated to 7.2% in May from 6.5% in April.

As bond prices rose, yields came down, with the yield on the 10-year Treasury note tumbling 4 basis points to 4.24%.

In Europe, the ZEW confidence index, which measures German investor and analyst expectations, fell to its lowest level since 1992, boosting demand for government bonds.

The gloomy index reading may deter the European Central Bank from raising interest rates, dealers said.

The yield on the 10-year bund eased 1 tick to 4.62%, while the two-year bund’s yield tumbled 6 basis points to 4.64%.

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