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By Ritvik Carvalho and Julien Ponthus
LONDON, Feb 4 (Reuters) - Money markets pushed their bets on negative UK interest rates out to February 2022 after the Bank of England said on Thursday British lenders would need at least six months to prepare for interest rates going below zero.
Shares in UK banks .FTNMX8350 rose 2% to their highest in over a week following the BoE's statement, after earlier trading in the red. Ten-year government bond yields rose to the highest since November.
Britain's FTSE 100 .FTSE index pared initial losses after the Bank's statement to traded 0.3% lower on the day, helped by the boost to bank stocks.
The pound GBP=D3 which traded 0.5% lower to the dollar before the BOE's statement, rose to trade 0.2% higher at $1.3675 amid relief there were no immediate plans to cut rates into negative territory.
It also hit a May 2020 high against the euro, gaining 0.8% to 87.52 against the single currency. EURGBP=D3
The British central bank said it would ask banks to get ready for the possibility of negative rates, but that financial markets should not view sub-zero borrowing costs as a foregone conclusion. BOE did sound mildly optimistic on the economic outlook and this in turn boosted the pound and weighed on the UK markets," said John Woolfitt, Director at Atlantic Capital.
"They also highlighted that, whilst at this point they do not want to set a negative interest rate, it is something they wouldn't rule out if needed."
UBS Global Wealth Management said the tone "especially with regards to negative rates, was at the hawkish end of expectations".
Other announcements were in line with investor expectations.
The BoE kept its stimulus programme unchanged at a total of 895 billion pounds and maintained its Bank Rate at 0.1.
Money markets pushed out expectations for a rate cut by six months to February 2022, before paring them back to December 2021. Before the BOE statements, bets were for rates to be cut to sub-zero in August 2021 BOEWATCH
Ten-year gilt yields rose to their highest levels since March 2020, up 9 basis points on the day. Two-year yields rose to -0.001%, up 7 bps on the day. GB10YT=RR
The British yield curve, measured as the spread between 10- and two-year bond yields, steepened to its highest levels in nearly a year at 47 bps compared with 32 bps, in line with the BOE's cautiously optimistic forecast. GB2GB10YT=RR
"While UK pension funds will always require sizeable holdings of UK government bonds, we think many investors should increasingly look overseas for part of their government debt allocations," said Vivek Paul, UK chief investment strategist at BlackRock (NYSE:BLK) Investment Institute.
"Given the Bank's cautious stance on the prospect of negative interest rates domestically, UK gilts have much less room to fall from current levels than U.S. treasuries, for instance, and so would provide less risk-off ballast in a multi-asset portfolio. Furthermore, Chinese government debt is under-owned by UK investors in our view."
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