British midcap index slumps to eight-month low as gilt yields surge

(Reuters) -Locally-focused British stocks were slammed on Wednesday alongside sterling, while benchmark UK gilt yields soared as investors grappled with the prospects of higher interest rates and stubborn inflation.

The domestically-focused FTSE 250 mid-cap index fell nearly 2% to a five-month low.

The blue-chip FTSE 100 was broadly flat, cushioned by a 1% drop in sterling that helped international firms on the index that draw a major portion of their revenues overseas.

A selloff in some of the world's biggest government bond markets appeared more pronounced in UK gilts, fanning worries about the impact of higher borrowing costs on the British government's already shaky finances.

Thirty-year gilt yields hit their highest since 1998 at 5.383%, while 10-year yields rose as high as 4.821% to levels last seen in 2008.

"It's somewhat odd that bond yields have risen to new highs so long after interest rates have peaked, which suggests markets were complacent about inflation and overly confident that the Bank of England would cut rates sharply," said Laith Khalaf, head of investment analysis at AJ Bell.

Gilt yields have risen in recent weeks as most investors now expect the Bank of England to cut rates by only about half a percentage point this year, while inflation looks likely to hover above the central bank's 2% target.

Utilities, often traded as a bond proxy owing to their stable income regardless of the economic situation, dropped 1.8%.

Heavyweight Shell shed 1.4% after the energy major trimmed its liquefied natural gas production outlook for the fourth quarter and said oil and gas trading results were expected to be significantly lower than in the previous three months.

Stocks in aerospace and defence provided a bright spot, helping the FTSE 100's rise earlier in the session, after U.S. President-elect Donald Trump called for higher spending from NATO allies.

Rheinmetall, Dassault Aviation, Leonardo and BAE Systems rose between 3% and 5.1%.

Separately, UK investors added a record 27.2 billion pounds ($34 billion) to their stock holdings in 2024, funds network Calastone said, as a surge in investments in index-tracker funds dominated.

(Reporting by Shashwat Chauhan and Medha Singh in Bengaluru; Editing by Janane Venkatraman and Gareth Jones)