* Sterling at five-year highs after BoE rate hike warning
* FTSE 100 closes down 1 pct at 6,777.85 points
* Two-year UK gilt yields soar
* S&P upgrades rating on UK's outlook to stable
* FTSE 100 at lowest level since late April
(Updates prices, adds fresh comments)
By Anirban Nag and Sudip Kar-Gupta
LONDON, June 13 Investors braced on Friday for a
UK interest rate hike later this year, pushing sterling to
five-year highs and hurting property stocks, after the Bank of
England's head said rates may rise sooner than markets expect.
Bank of England Governor Mark Carney's surprisingly stark
warning late on Thursday prompted investors to bring forward
expectations for a first BoE rate hike by nearly four months, to
December from the first quarter of 2015.
"We have a financial system which is on a hair trigger,"
said Stewart Cowley, an investment director at Old Mutual Global
Sterling's trade-weighted index hit 5-1/2-year highs and
posted its biggest one-day rise in four months.
Shorter-dated British government bond prices plummeted, as
the two-year gilt yield soared by the largest amount
in more than three years, according to Reuters data.
While sterling rose on the currency markets, Britain's
benchmark FTSE 100 equity index fell 1 percent to
6,777.85 points, its lowest close since late April. A stronger
pound can hit companies' exports.
Raising rates is also often used to prevent a country's
housing market from overheating, and housebuilding and property
shares slumped on Friday, with Persimmon and Barratt
Developments falling by 7 and 6.3 percent respectively.
Carney had recently been of the view that rates would be
kept lower for longer to ensure a broad-based recovery.
The market now thinks the Bank of England could raise rates
at least six months before the U.S. Federal Reserve is expected
to tighten policy. That contrasts sharply with the European
Central Bank, which cut rates last week and is seen as likely to
ease policy in coming months.
"The BoE seems to be slightly ahead of the Fed as far as
rate hikes are concerned," said Commerzbank currency analyst
Economists think British interest rates will start rising in
the first quarter of 2015, according to a Reuters poll conducted
on Friday, a day after Bank of England Governor Mark Carney said
rates may rise sooner than markets expect
UK ELECTION AROUND THE CORNER
Short sterling futures also fell across the strip <0#FSS:>,
pricing in a first hike by December. The sterling overnight
interbank average curve (SONIA) was pointing on
Friday to a chance of a rate hike by the end of the year,
compared with the first quarter of 2015 on Thursday.
Britain's economy is outperforming its peers, growing at a
near 3 percent annual rate, and credit rating agency Standard &
Poor's on Friday raised its credit outlook on the UK to "stable"
However, UK house prices are up 11 percent over the past
year, pressuring policymakers to prevent a bubble and Britain
faces an election in May 2015 in which living standards and the
cost of housing are expected to be major issues.
Sterling hit a fresh 5 1/2-year high in a trade-weighted
basket of currencies, rising to 88.2. 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.
Sterling implied one-month volatility also rose to a
six-week high above 5 percent but soon came back down, remaining
at less than a quarter of its peaks in 2008.
The euro currency fell to 79.765 pence, its
lowest since November 2012. The euro has shed nearly 2 percent
since the European Central Bank cut rates last Thursday.
The premium that gilts offer over German Bunds rose
markedly, reflecting the diverging outlooks for British and euro
zone interest rates.
The yield spread between two-year British and German bonds
rose to a session peak of 86.6 basis points, the
highest since around late 2008, according to Reuters data.
"These comments should help prompt a sustained move towards
higher front-end yields," said Jamie Searle, strategist at Citi.
(Additional reporting by Andy Bruce, Patrick Graham and Tricia
Wright, Editing by Larry King)