UK Surprises Again

For the second consecutive session, the UK has surprised the market. The impact of yesterday's shocking 0.5% Q4 contraction has been blunted by the unexpected BOE vote 7-2 in favor of steady interest rate policy, as the newest member (Weale) joined Sentance's dissent for a 25 bp rate hike. Given that the MPC would not have known that the economy contracted, suggested that the minutes might be too historical to be of much interest to the markets. Instead, the news and the somewhat hawkish tone to the overall minutes has prompted a sharp sell-off in UK debt, with implied yields on the short sterling futures give back the lion's share of yesterday's gains.

We note that MPC member Posen still favored the BOE buying another GBP50 bln of gilts. Sterling's recovery off $1.5750 low yesterday and has retraced half of yesterday's losses. Additional gains may be hard to come by, but the general soft US dollar environment poses risk. The $1.5900-20 area is the next obstacle. Note that although sterling has traded above the $1.60 level intra-day for the last six sessions before today, it has not finished the 24-hour session above there once. The minutes also steadied sterling against the the euro. Earlier, the euro pushed marginally through yesterday's high near GBP0.8670. Look for sterling bears to make a stand near GBP0.8600.

The euro's advancing streak continues today for the seventh consecutive session, It has had only one losing session since January 7 and that wsa MLK holiday when the US markets were closed.

The successful EFSF bond sale yesterday has done no favors for the peripheral European bonds today. Spreads against Germany are widening even as German rates rise. Irish and Portugese 10-year yields are up 9-10 bp. Greece and Spain up 6-7 bp. Pressure is also evident in the 2-year area. Irish 2-year is up 19 bp, following central bank comments warning that Irish banks may need more funds. Spanish 2-year yield is 9 bp higher following cautionary comments by Fitch.

The German 2-year yield is up 5 bp to new 1 year highs, following the jump in import prices to the highest level since late 1981 at 12% year-over-year. The consensus called for an increase from 10.0% to 10.8%. The month-over-month figure was nearly twice the consensus at 2.3% vs 1.2%. This clearly reflects energy (+34.2% year-over-year) and metal prices (iron ore 98% year-over-year and 38% other metals).