UK bonds may fall, BOE to lift rates

UK government bonds may decline on speculation the Bank of England will keep raising interest rates to curb inflation. Gilts had their biggest annual loss since 1999 last year after the central bank unexpectedly raised borrowing costs in August and increased them again in November.

Europe's second-largest economy grew at the fastest annual pace in two years in the third quarter and has shown few signs of slowing even after the two interest-rate increases.

"The general sentiment is that the risks of a rate hike in February remain high,'' said Marc Ostwald, a bond analyst at Insinger de Beaufort in London. "If people are going to get particularly negative on the rate outlook then there's not going to be a rush of people looking to buy at current yield levels."

The yield on the two-year note was little changed at 5.18 per cent at 10:47 a.m. in London, a gain of 102 basis points in 2006. The price of the 5 percent gilt due March 2008 was at 99.79.

The Chartered Institute of Purchasing & Supply and Royal Bank of Scotland Group Plc today said its index measuring factory growth dropped to 51.9 last month from 52.6 in November.

A reading above 50 denotes expansion. The survey showed manufacturing, which accounts for about 15 percent of Britain's gross domestic product, grew in every month in 2006.

The central bank said on Nov. 9 that it expects inflation to "rise further above target in the near term, but then fall back as energy and import price inflation abate".

Bets by traders on a further interest-rate increase by the Bank of England are also sending yields higher. Interest-rate futures trading shows investors expect the bank to lift rates once more by the end of the first quarter.