UK gilts scorched again as Iran war rages, BoE rate hike bets rise

By Andy Bruce

MANCHESTER, England, March 12 (Reuters) - British government bonds slumped again on Thursday, and the escalating conflict in Iran pushed investors back to pricing in a Bank of England rate hike this year amid worries about Britain's vulnerability to the energy price shock.

Unlike in previous days when the heaviest losses were in interest rate-sensitive short-dated bonds, long-dated bonds fell the most sharply on Thursday, reflecting concerns over possible extra government borrowing to fund support for energy users.

Ten- GB10YT=RR and 20-year gilt yields GB20YT=RR, which move inversely to prices, were both up around 10 basis points on the day at 1547 GMT, the former reaching its highest level since September at 4.804%.

Short-dated bonds fell heavily again as markets bet increasingly on the BoE's next move being an interest rate hike - a prospect viewed as extremely unlikely only a week ago.

Rate hike bets increased as oil prices surged, touching $100 per barrel in earlier trading.

Interest rate futures were pricing in a roughly 60% chance of a quarter-point rise in borrowing costs by the BoE in December, compared to expectations of no change on Wednesday.

"Faced with an overwhelming number of unpredictable variables, nobody expects the Bank to do anything other than wait and see," said Danni Hewson, head of financial analysis at AJ Bell, referring to next Thursday's interest rate announcement after the March meeting of the Monetary Policy Committee.

"But this decision will still be a difficult one, and close attention will be paid to any guidance about the path ahead."

Investors view Britain as more exposed than many other Western countries to an energy price shock due to its stretched public finances and its heavy reliance on imported gas.

The drop in gilt prices represents a marked tightening of financial conditions in Britain, something the finance ministry and BoE will be watching with concern with economic growth already weak.

Iran's new Supreme Leader Mojtaba Khamenei said on Thursday the country will fight on and keep the Strait of Hormuz shut.

The five-year yield, sensitive to changes in the medium-term outlook for interest rates, is up 63 basis points this month - the biggest rise since September 2022 when then Prime Minister Liz Truss announced her ill-fated economic agenda.

Prior to 2022, January 1996 was the last time five-year yields rose by so much.

Despite the plunge in gilt prices this month, investor appetite in sales to the primary market has stayed strong.

An 500 million-pound ($667.8 million) auction of index-linked gilts due in 2049 drew solid demand, drawing bids worth 3.57 times the amount on offer.

($1 = 0.7487 pounds)