UK gilts rally as service PMI weakens and BOE lowers regulatory buffers

The UK gilts strengthened on Tuesday after data showed that service PMI fell more than expected in June. Also, the Bank of England announced in its financial stability report that they will reduce counter cyclical capital buffer to 0.0 percent from 0.5 percent with immediate effect until June 2017 at the least.

The yield on the benchmark 10-year gilts fell nearly 4 basis points to 0.803 percent, yield on super-long 50-year bonds dipped 3 basis points to 1.407 percent and the yield on 30-year bonds slid 2-1/2 basis point to 1.633 percent by 10:15 GMT.

The fall in the UK June services sector PMI, to 52.3 from 53.5 in May is a weaker outturn than the 52.7 expected by the market and should be interpreted as GBP negative. The fall, combined with the effects of the plunge in the construction sector PMI into deep contraction territory, causes the Markit-calculated composite PMI to dip perceptibly, to 51.8 in Jun (its lowest since Mar 2013), from an upwardly revised 52.9 in May (prev 52.8). The quarterly average of the composite PMI thus falls to 52.7, from 54.2 in Q1 and points towards a growth deceleration in Q3.

The Bank of England (BoE) in its financial stability report concluded that they will reduce counter cyclical capital buffer to 0.0 percent from 0.5 percent with immediate effect until June 2017 at the least and CCB cut will reduce buffer by 5.7 billion pounds and raise bank lending capacity by 150 billion pounds. They further added that FPC is ready to take any further action needed to support financial stability and will give insurers more flexibility to deal with a sharp fall in market interest rates.

Moreover, they also added that the BoE stands ready to take action to ensure capital and liquidity buffers can be drawn on to support lending and the BoE needs to reduce any pressure on firms to restrict supply of credit and provision of financial services. The BoE closely monitoring commercial real-estate, buy-to-let, investor appetite for UK assets and fragile market liquidity and current outlook for financial stability is challenging and some Brexit risks are starting to crystallise, they added.

The BoE Governor Mark Carney said that that BOE will adjustments in commercial real-estate and will tighten credit conditions, there is growing evidence that post-Brexit uncertainty has delayed decisions on investment. Said financial markets have coped well with Brexit volatility and markets are focused on banks returns not resilience. Also said that the central bank can provide substantial FX liquidity if required, sees institutions using liquidity to finance loans and will use the flexibility in UK regulations to the greatest extent possible.

He further added that the BOE will ensure that no bank increases dividends or distributions to shareholders due to BOE rule changes and BOE cannot fully offset Brexit volatility. Future potential of the UK economy is not the gift of the BOE but will be driven by others in the private and public sectors, he added.

On Monday, the UK June construction PMI reading of 46.0 vs 51.2 in May is by far and away worse than the 50.5 expected by the market consensus and even undershoots the 49.0 that marked the bottom end of the range of forecasts.

This reading was the weakest since Jun 2009 and is clear evidence of how hard the uncertainty surrounding 'Brexit' has hit the construction sector, especially in house building and commercial property construction, even though it caused a dent in the manufacturing sphere last month.

Meanwhile, the FTSE 100 trading up 0.12 percent at 6,531 by 10:15 GMT.