European govt bonds lower, led down by sharp falls in gilts after UK PPI data

LONDON (Thomson Financial) - European government bonds were lower, led down by significantly falls in gilts after very strong UK producer price inflation data suggested the Bank of England will have little room to cut interest rates.

The figures showed UK input prices jumped by 2.6 pct in January from December, way above analyst expectations for a 1.3 pct rise and giving a massive annual rise of 19.1 pct, the biggest increase for 22 years.

Output price figures meanwhile showed that companies have had to pass on these extra costs into their prices, with the monthly rise of 1.0 pct the biggest since January 1995 and the annual rise of 5.7 pct the highest since July 1991.

"For a market which is aggressively priced for future easing, this will make for uncomfortable reading and rate cut expectations will need to be pared back," said Daragh Maher at Calyon.

Last week, the Bank of England cut interest rates by a quarter point to 5.25 pct in order to revive flagging demand in the economy and following up the cut in December, but Monetary Policy Committee members have continued to warn of rising inflationary pressures.

"There are plenty of lingering hawks on the Monetary Policy Committee who will point to today's data as further reason to be careful about cutting rates too quickly," Maher said.

Renewed fears over inflationary pressures and the sharp drop in gilts dragged European bonds lower too, though they underperformed their UK counterparts.

With little on the European and US calendars for today, bond market participants are likely to continue to look to developments on equity markets for direction.

Otherwise, the outlook for European bonds remains cloudy after market participants last week focused on the more dovish elements of an otherwise hawkish speech by European Central Bank president Jean-Claude Trichet on Thursday following the decision to leave interest rates on hold.

Trichet maintained his optimistic stance in an interview with Japanese papers over the weekend, saying that the euro zone economy is still experiencing significant growth and is not in the same situation as the US economy.

The G7 communique from this weekend's meeting in Tokyo, however, provided reasons for continued risk aversion as it focused heavily on the ongoing credit crunch and risks to global growth.

US Treasury Secretary Henry Paulson said the turbulence in financial markets is both "serious" and "persisting," and he expects "continued volatility as risk is repriced."

At Yield Change on

1045 GMT pct previous close

March euribor future (Liffe) 95.75 dn 0.06

June euribor future (Liffe) 96.21 dn 0.06

GERMANY

March bund future (Eurex) 117.17 dn 0.06

4.00 pct Jan 2018 govt bond 100.97 3.87 dn 0.04

FRANCE

4.25 pct Oct 2017 govt bond 101.08 3.98 up 0.06

ITALY

5.25 pct Feb 2018 govt bond 102.43 4.24 up 0.07

UK

March gilt future 110.36 dn 0.49

5.00 pct March 2018 govt bond 104.56 4.47 dn 0.03

March short sterling future 94.43 dn 0.08

June short sterling future 94.86 dn 0.10

jessica.mortimer@thomson.com

jkm/slm

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