Carney does little to change BoE rate hike expectations
* Rate markets still pricing in tightening in early 2015
* Sterling recovers from two-week lows
* Lower liquidity buffer announcement pushes up gilt yields
By Anirban Nag
LONDON, Aug 28 (Reuters) - Bank of England Governor Mark Carney's first public speech did little to alter market expectations that interest rates could rise much earlier than flagged.
A gauge of near-term interest rate expectations, sterling overnight interbank average rates (SONIA) still priced in the chance of a first rate rise in less than two years, , broadly unchanged from before Carney's speech.
Sterling also recovered from two-week lows against the dollar to trade flat on the day while gilt yields inched up to hit two-year highs.
Investors had anticipated Carney would try to talk down a sharp rise in UK money market rates, which followed a run of forecast-beating economic data.
Carney earlier this month issued unprecedented "forward guidance" on monetary policy, saying interest rates would stay at a record low 0.5 percent until unemployment fell to 7 percent - something he said could take three years.
However, in light of the strong data, markets were not persuaded it would take that long, pushing short-term interest rates higher and pricing in a hike in the BoE's base rate earlier than suggested by the guidance.
But Carney's latest speech fell short of expectations of investors who had geared up for a far more aggressive bid to dampen expectations of monetary tightening.
"He discusses a rise in market rates but does not appear concerned by it," said Philip Rush, economist at Nomura. "He is not leaning against it yet."
Carney said that while a UK recovery was broad based and looked set to continue, the unemployment rate would not fall quickly to a level where the bank would consider raising rates.
SONIA rates priced in a slim chance of a BoE hike by February 2015. The 18-month rate traded at 0.4825 percent , up from 0.46375 before the speech while the two-year rate rose to 0.55625 percent from 0.52375 percent.
"For the time being, the market remains unconvinced about forward guidance given the first rate hike is priced for early 2015," said Sam Hill, fixed income strategist at RBC Europe Limited.
Sterling rose to $1.5553 after Carney's comments from a two-week low of $1.5427 struck briefly after the BoE chief spoke. The euro fell to 85.72 pence after his comments, down from 86.335 beforehand.
The rise in money market rates and yields has supported the pound, which is up 2.1 percent against the dollar and has gained 1.9 percent against the euro so far this month.
Gilt futures reversed gains to last trade 18 ticks down on the day at 110.08, from 110.70 before Carney's comments. The 10-year gilt yield hit a two-year high of 2.81 percent, up from 2.76 percent beforehand.
Some traders said the rise in yields was also due to Carney's announcement that banks will be able to reduce their liquidity buffers. Banks bought billions of pounds of bonds in 2009 and 2010 to comply with tighter rules. [ID: nL6N0GT2F1]
Much of this buying was in gilts, but triple-A rated agency debt and deposits are also included so the relaxation could see banks paring their gilts portfolio.
"The relaxation in liquidity requirements should help to improve the supply of credit and therefore be positive for the real economy, bringing forward the time at which policy can be normalised," said Simon Hayes, economist at Barclays.
"The financial market reaction - a strengthening in sterling and a fall in gilt prices - therefore seems appropriate."
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