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THOUGHTS ON THE GILT MARKET

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Gilt yields drifted higher over the past seven days, despite a set of economic releases in the UK that generally su...
Gilt yields drifted higher over the past seven days, despite a set of economic releases in the UK that generally supported the chancellor's move to cut base rates to 5.75% on June 6th. As is often the case, overseas influences were dominant.

Last week's UK economic data showed that the manufacturing sector of the economy still has problems. Output is stagnant and employment is being cut back because demand remains insufficient to allow firms to reduce stocks back to their desired levels. As a result, companies are finding it difficult to raise their prices aggressively and producer output price inflation has fallen sharply over the last year.

The rest of the economy is faring a little better, as evidenced by the fall in unemployment of nearly 15,000 in May. But total output is not strong enough to threaten a rise in inflation pressures and the latest retail price data, for May, show a fall in the headline rate to 2.2%, its lowest since September 1994.

Such signs of subdued output growth and low inflation would normally be positive for the gilt market, leading to lower yields. But bond markets around the world are focused at the moment on developments in the United States.

The latest economic data from the US confirm that output growth has strengthened considerably this year - annual industrial output growth is now above 3%. Although there are few signs of an increase in inflation pressures yet, most commentators now expect the Federal Reserve to increase interest rates, either in July or August to prevent them developing in the second half of the year. Bond yields in the US have increased as a consequence, and this has put upward pressure on yields in other countries, including the UK.

Unless there is some evidence that the spurt in US output growth will prove short-lived, such conflicting pressures on yields - favourable domestic influences versus unfavourable overseas ones - are likely to remain.

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