Pound and gilts fall after shrugging off BoE balancing act

By Jaspreet Kalra, Naomi Rovnick and Canan Sevgili

MUMBAI/LONDON (Reuters) - The pound slipped and gilt yields rose on Thursday, reversing course after having offered a muted reaction after the Bank of England kept rates unchanged and slowed the pace of its government bond holding reductions.

Analysts said the shift appeared to stem more from stronger U.S. employment data that boosted the dollar broadly and sent bond yields higher than from the BoE's policy steps.

Sterling was down 0.6% at $1.3541, while the yield on the benchmark 10-year gilt rose 5 basis points to 4.67%.

"I don't see any sort of clear catalyst for the move, besides the fact that it seems to have gathered momentum since U.S. traders entered the fray," said Michael Brown, senior research strategist at Pepperstone.

Earlier, BoE policymakers voted 7-2 to keep rates unchanged at 4% while slowing the annual pace at which the central bank sells gilts it purchased between 2009 and 2011 to 70 billion pounds from the current 100 billion pounds, in line with economist forecasts.

UK inflation is almost twice the central bank's 2% target, and there are growing signs of weakness in the labour market. Yet money markets are only fully pricing in another rate cut by March next year, something some investors believe may be overly pessimistic.

"There could be good news on the horizon that allows a few more cuts than the market expects. Commodity prices are not going up and that may weigh on inflation," said Christopher Mahon, multi-asset manager at Columbia Threadneedle.

MOST STAGFLATIONARY DEVELOPED ECONOMY

"The UK is now the most stagflationary economy in the developed world. A brutal mix of high inflation, weak growth, and rising unemployment," said Lloyd Harris, head of fixed income, Premier Miton Investors.

"The next big moment for the BoE and for all sterling markets is the Autumn Budget," Harris said.

Finance Minister Rachel Reeves will present her budget on November 26. She is under pressure to stick to her own rules on borrowing to keep Britain's finances on track, as reflected in some of the large swings in yields on long-term UK bonds this year.

The central bank said it would skew sales away from long-dated gilts to minimise the impact on turbulent bond markets. Britain's 30-year borrowing costs had climbed to their highest level since 1998 earlier this month but have since eased.

"The Bank of England's decision to slow its pace of bond sales was fairly consensus, but the decision to skew those sales towards shorter maturities should provide some relief to the long-end," said Matthew Landon, global market strategist at J.P. Morgan Private Bank in London.

The 30-year gilt yield was last up 6 bps at 5.493%, tracking a similar sized move in its U.S. counterpart. Germany's 30-year bond yield was up 6 bps as well at 3.30%.

The BoE is alone among major central banks in conducting outright sales of the government bonds it bought to boost the economy in the years after the 2008 global financial crisis, rather than just letting them mature.

British stocks held on to their post-BoE gains, with the benchmark FTSE 100 stock index last up 0.3%, while the more domestic-focused mid-cap stock index was up nearly 0.4%.

"There’s always going to be some sensitivity around the future inflation profile. And given the background of where the UK has been, I expect the Bank of England to remain cautious," Matt Hudson, UK portfolio manager at River Global, said.

(Additional reporting by Yoruk Bahceli in London; Editing by Amanda Cooper and Joe Bavier)