UK gilts plunge on higher Chinese manufacturing PMI; BoE’s policy decision in focus

The UK gilts plunged Tuesday after recent data showed that the world’s second-largest economy’s manufacturing activity expanded at a faster pace in October. Also, markets largely shrugged off a fall in UK’s October manufacturing PMI.

The yield on the benchmark 10-year gilts, which moves inversely to its price, rose 3 basis points to 1.273 percent, the super-long 40-year bond yield climbed 2 basis points to 1.74 percent and the yield on short-term 2-year bounced 1 basis point to 0.267 percent by 10:10 GMT.

The Caixin China manufacturing purchasing managers’ index (PMI) rose to 51.2 in October, analysts were expecting a slight increase to 50.2 from a reading of 50.1 the previous month. Anything above 50 is associated with expansion. Also, China’s official non-manufacturing PMI rose to 54 in October from 53.7 in September.

The preliminary output-based UK Q3 GDP growth rate of 0.5 percent q/q is even stronger than our above-consensus prediction of 0.4 percent (the market sought 0.3 percent) and takes the annual rate up to 2.3 percent y/y from 2.1 percent in the second quarter and vs 2.1 percent expected by the market consensus.

Last week’s GDP data has reduced the chances of further easing at BoE's meeting scheduled Thursday, November 3. We expect the meeting to end in the decisions to maintain the official Bank Rate at 0.25 percent and keep the programme of asset purchases paused at 435 billion British pounds for Gilts and at 10 billion British pounds for corporate bonds.

Moreover, the Bank of England Governor Mark Carney in its latest interview said that pounds move has been substantive and there has been a fairly substantive move in the British exchange rate, which the MPC has to take into account in its policy deliberations. He said that the MPC, however, needs to consider how persistent the move in pounds is likely to be.

This gives us a pretty strong signal that the BoE MPC might, after all, choose to stand pat at the Nov meeting; the more so as Carney says that monetary policy has been overburdened. This suggests that he’d prefer fiscal policy to now take over the baton in pursuant of the authorities’ dash-for-growth objectives. This should calm pounds nerves somewhat for the time being, following the sharp Cable sell-off seen during the latter part of Tuesday’s session.

In addition, the UK government bonds have been closely following developments in oil markets because of their impact on inflation expectations. Crude oil prices rose on fresh investors buying after crude oil prices fell below $50 mark. The International benchmark Brent futures rose 0.56 percent to $48.88 and West Texas Intermediate (WTI) climbed 0.21 percent to $46.96 by 09:20 GMT.

The acceleration of UK CPI inflation to 1.0 percent y/y from 0.6 percent in August occurs on the back of a 0.2 percent m/m increase and stands at its highest reading since November 2014. The m/m increase, driven higher by road fuel costs, clothing & footwear costs, hotel accommodation costs and gas prices, is actually consistent with the average m/m rise for a September month over the past 10 years.

Meanwhile, the FTSE 100 traded 0.21 percent higher at 6,968.30 by 10:00 GMT.