By Alun John
LONDON (Reuters) -Rate-sensitive short-dated British government bond yields dropped on Thursday and real-estate stocks rose, after the Bank of England raised interest rates by 25 basis points, a step down in the pace of monetary tightening from its previous meeting.
The BoE raised its key interest rate by a quarter point to a 15-year peak of 5.25%. Market pricing ahead of the meeting had reflected a reasonable chance of a 50-basis point increase.
However, unlike the U.S. Federal Reserve or the European Central Bank - which also both raised rates by a quarter-point last week - the rate-setting Monetary Policy Committee gave little suggestion that hikes were about to end as it battles high inflation.
The two-year yield dropped as much as 14.9 basis points, and was last down 6 basis points at 4.94%.
Shares in homebuilders and real estate companies, which have suffered in recent months as higher mortgage costs raised prices for home buyers, rallied, each up around 0.75%.
Moves in benchmark 10-year gilts were more muted. The yield briefly dipped to trade flat on the day after BoE's move, but was last up 4.5 basis points at 4.45%. Bond yields move inversely to prices.
Due to broad pessimism across share markets globally, the FTSE 100 remained down 0.8% on the day and the mid-cap FTSE 250 only just edged into positive territory.
"The recent fall in inflation and signs of a faltering economy meant that the (rate-setting) MPC felt it had enough room to revert back to a 25bps rise in August," said Thomas Pugh, an economist at RSM UK.
"However, one weak data point will not be enough for the Bank to be satisfied that inflation is now on a sustainable trajectory. We expect at least one more 25bps rate hike in September, whether that is followed by another one will depend on the inflation and labour market data between now and then."
The pound fell by as much as 0.66%, hitting a fresh one month low after the meeting's outcome. It was last at $1.266, 0.4% lower on the day, roughly where it was before the announcement.
This softness marked something of a reversal, as sterling was the best performing major currency against the dollar in the first half of the year because of expectations the BoE would have to raise rates further than global peers.
Market expectations for the Bank Rate peak reached 6.5% in mid July before falling back to 5.75% before the decision after a sharp decline in consumer price inflation which echoed declines elsewhere in the world, particularly the United States. After the BoE's move, traders saw rates peaking at 5.71% in March.
"We still see sterling moving higher from here on rate differentials between the United States and Britain," said Yvan Berthoux, an FX strategist at UBS.
He said monetary policy would have to remain tighter in Britain than in the U.S., and that while there had been one softer British inflation print, the recent move lower in rates around the world was mainly in response to cooling U.S. inflation.