UK markets scramble to price in 2014 rate rise after Carney warning

Fri Jun 13, 2014 5:23am EDT

(Updates prices, adds fresh comments)

By Anirban Nag and Tricia Wright

LONDON, June 13 (Reuters) - Investors priced in a rise in UK interest rates as soon as year-end on Friday, sending sterling to five-year highs and hitting property stocks, after the Bank of England chief said rates could rise sooner than markets expected.

Governor Mark Carney's surprisingly stark warning late on Thursday prompted investors to bring forward expectations for a first BoE rate hike to before the end of this year, from the first quarter of 2015.

Sterling's trade-weighted index posted its biggest one-day rise in four months, hitting 5 1/2-year highs.

A possible rate hike by the BoE by the end of 2014 would make it the first major central bank to normalise monetary policy since the global financial crisis broke out in 2008.

A hike is likely to come at least six months before the U.S. Federal Reserve is seen tightening policy and contrasts sharply with the European Central Bank, which cut rates last week and is likely to ease policy in the coming months.

Carney said he was also concerned by signs that mortgage lending standards were becoming looser and set out the case for early action as insurance against future risks.

While Britain's economy is outperforming its peers, growing at a near 3 percent annual rate, house prices are up 11 percent over the past year, pressuring policymakers to prevent a bubble.

Britain faces an election in May 2015 at which living standards and the cost of housing are expected to be major political battlegrounds.

London's main share index was down 0.5 percent by 0845 GMT, with housebuilders Persimmon and Barratt Developments both losing more than 4 percent.

Short sterling futures fell across the strip <0#FSS:>, pricing in a first hike by December. The sterling overnight interbank average curve (SONIA) was pointing to a chance of a rate hike by the end of the year, compared with the first quarter of 2015 on Thursday.

"The BoE seems to be slightly ahead of the Fed as far as rate hikes are concerned," said Lutz Karpowitz, currency analyst at Commerzbank. "Macro data is likely to attract particular attention over the coming months. Anything pointing towards a possible rate hike would then support the pound further."

Sterling hit a fresh 5-1/2 year high on a trade-weighted basket of currencies, rising to 88.1. Britain's recovery has pushed the index 8 percent higher over the past year as investors priced in growing chances of rate hikes by the BoE.

The euro fell to 79.85 pence, down 0.2 percent on the day, and its lowest since November 2012. The euro has shed 1.8 percent since the ECB cut interest rates last Thursday.

The diverging UK and European policy outlooks have pushed the difference in yields between British and German 10-year government bonds to its widest since 1997.

The pound hit $1.6995, its highest since reaching $1.6997 on May 6. Above $1.6997, sterling will be at its highest since August 2009, with bulls now targeting the $1.70 mark.

"The pound has maintained its close relationship to the changes in market rate expectations as expressed by the front end of the money market curve. Hence, we would expect the pound to push higher and we maintain our forecast of $1.75," Morgan Stanley said in a morning note.

STOCKS HIT

Analysts were relatively sanguine on housebuilding stocks, saying Friday's falls should be seen in the context of strong share price runs. While higher rates would raise the costs of borrowing to build, it would also signal the economy - and consequently funding prospects - were looking brighter.

"Markets are obviously now anticipating that interest rates will rise - it'll just take some of the froth off the strength that we've seen (from housebuilders)," said Richard Hunter, head of equities at Hargreaves Lansdown.

The pain was felt throughout the property sector, with Land Securities and British Land both left nursing falls of 2.8 percent. (Additional reporting by Patrick Graham; Editing by Nigel Stephenson and Catherine Evans)