London Market: Gilts could go down as economy gears up

GILTS may fall this week on the expectation that further evidence that the economy is rebounding will persuade the Bank of England not to cut interest rates at its monetary policy meeting this week.

"I think it will be another bad week for gilts," said Neil Parker, senior economist at Royal Bank of Scotland. "The Monetary Policy Committee will be on hold, and although there is not much data out, the stuff we are getting is likely to confirm the UK economy is moving up a gear."

Gilt yields rose to their highest levels since November last week as reports and surveys painted a picture of economic improvement. Buoyant consumer credit, an expanding service industry, retail sales growth, rising house prices and a recovery in manufacturing were all reported.

The benchmark 10-year bond yield rose 10 basis points to 4.96, its highest since November. While many economists expect rates to stay on hold when the central bank meets on Wednesday and Thursday, a majority still forecast lower borrowing costs by the year-end. "A move this month is unlikely," said Richard Iley, an economist with ABN Amro. "But short of a dramatic collapse in the pound over the next month, a cut in July looks increasingly certain."

Some analysts said a cut cannot be ruled out this week, given the strength of the pound, and that the MPC's voting will once again be close. "The domestic economy is improving, but sterling has risen significantly since the bank last met," pointed out Nick Stamenkovic, bond strategist at Idea Global. "That increases the chances of the inflation target being undershot."

Vodafone, the mobile-phone company, may boost phone companies before reporting its earnings on Tuesday. Hopes for more mergers in the telecoms industry are also likely to boost stocks. Vodafone is expected to report a 31 per cent increase in full-year profit. Comments by Deutsche Telekom on Friday that it wants to raise $13bn (pounds 8.07bn) to invest outside Germany may also fuel merger speculation.

"We have changed our weighting from neutral to overweight in telecoms because there's good visibility for future earnings," said Charles Maisey, investment director of Quilter & Co. He also expects UK telecommunications companies to be a target for Deutsche Telekom, because Britain is "one of the more open markets in terms of regulation, so it is a natural place to look".

The benchmark FT-SE 100 index rose 2.6 per cent last week.