Gilts, Sterling, and European Bonds

UK gilts and sterling itself responded positively to earlier news that the BOE's reverse auction to buy GBP3.5 bln was well received. There were offers for GBP4.3 bln. The BOE will conduct another reverse auction on 1 July and buy GBP3 bln worth of bonds.

When this week's purchases are complete, the BOE would have bought about GBP105 billion worth. The BOE has indicated it will buy GBP125 billion of gilts, though it has authority to buy as much as GBP150 billion of assets. Although the BOE could shed fresh light on its intentions at this week's MPC meeting, many observers suggest the Aug meeting is more likely to see the program tweaked.

The combination of the reverse auction and earlier news from the UK's largest business lobby group that financial services companies will lay off another 13k workers in Q3 and new mortgage lending fell to its lowest level since 1993, when the time series began, sent the yield on the benchmark 10-year gilt to its lowest level in six weeks.

Sterling continues to bump along a ceiling created by the trend line drawn off this months highs and currently comes in just below $1.66. The high from the start of the month near $1.6660. A convincing break would suggest initial potential toward $1.70. Sterling is also trading on the firm side against the euro. Support at GBP0.8475 held on the initial test, but the market seems inclined to continue to test it, with a break spurring a return toward GBP0.8400. Sterling is also poised to extend gains against the yen. A firm close today see a move to JPY160 and then the mid-month high near JPY162.60.

European bonds extended last week's rally today, with most 10-year yields off 2-5 bp in the Europe. Gilts generally outpeformed with the 10-year yield off 7 bp to 7.6%. Note that Italian bonds have also performed well with yields off 9 bp on the day, doing today what it has taken German bunds 5 days to do. In the past week, other euro-zone bonds have outperformed bunds. We saw peripheral bond purchases as one of the consequences of the ECB's large injection of 1 year money last week. Greek bond yields are off 23 bp, Italian bonds yields off 16 bp over the past five sessions as bund yields decline 9 bp. Ireland is the noteworthy exception, as we anticipated. Irish 10-year yields have risen 7 bp over the past 5 sessions, due primarily to local factors.