* Graphic: sterling and gilt yields bit.ly/2dgAXn1
* Graphic: sterling year-to-date tmsnrt.rs/2egbfVh
By Jemima Kelly
LONDON, Oct 14 Yields on 10-year British
government bonds on Friday hit their highest level since June's
vote to leave the European Union and sterling held near record
lows as investors bet the currency's plunge would send inflation
Bank of England Governor Mark Carney told a public meeting
he was willing to allow inflation to run "a bit" higher than the
central bank's 2-percent target to help employment and allow
Britain's economy to grow.
His comments were echoed by fellow BoE policymaker Kristin
Forbes, who said inflation was already picking up, would
accelerate and could "sharply" overshoot the BoE's target over
the next two years.
Inflation is widely expected to rise above 2 percent in 2017
because of a sharp fall in the value of the pound - a 16 percent
tumble to record lows in trade-weighted terms.
At the same time, the economy is expected to slow as Britain
begins the complicated process of leaving the EU and tries to
negotiate new trade deals, leaving the economy facing a
potentially toxic mix of a tumbling currency, rising bond
yields, accelerating inflation and sluggish growth.
Ten-year gilt yields rose more than 10 basis
points to 1.149 percent, their highest level since Britain's
June 23 Brexit referendum. The rise in yields pushed the gap
over benchmark German Bund yields to about 107 bps -
its widest since late June.
"There's been a huge increase in inflation expectations and
bond yields are catching up," said Lyn Graham-Taylor, fixed
income strategist at Rabobank.
Sterling and gilt yields had until about two weeks ago moved
largely in sync, following the usual developed-market model of
higher market interest rates drawing in flows of capital.
But since sterling's latest lurch downwards on worries
Britain will undergo a "hard Brexit", yields have begun to
reflect concerns about UK inflation.
Gilt yields last Friday posted their biggest weekly rise
since August 2015, climbing 30 bps, and were on track to end
this week with a rise of about 15 bps.
Their bounce also reflects a broader rise in yields across
bond markets on the view that central banks are reaching the
limits of their policy of monetary easing, and that the U.S.
Federal Reserve will hike interest rates this year.
In contrast to gilt yields, sterling has lost almost 2
percent against the dollar this week. It was trading
down a third of a percent on Friday at $1.2210 and on track for
a fortnightly fall of almost 6 percent, its biggest since late
The pound's fall has stoked demand for inflation-linked
bonds, which has pushed real yields - nominal yields adjusted to
remove the effects of inflation - close to record lows.
"It's a combination of the result of rising yields globally,
the political noises about some of the negative impacts of QE,
and because of a rise in inflation expectations going forward as
a result of the fall in the pound," said Insight's head of
currency investment and fund manager Paul Lambert.
The volume and value of UK government bonds changing hands
since the vote for Brexit has soared by as much as 400 percent,
figures from Trax - a subsidiary of MarketAxess - showed earlier
Sterling's plunge has also boosted the many
internationally-focused, dollar-earning companies on Britain's
blue chip FTSE 100 index, which enjoy a currency-related
accounting lift as those dollars are converted back into pounds.
The FTSE 100 stands more than 11 percent above its
pre-Brexit level, while the more domestically-exposed FTSE 250
has gained nearly 4 percent.
While a drop in sterling hampers British mid-cap firms,
which are seen as a play on the UK economy, they have been
lifted by better than expected post-Brexit economic data, as
well as the prospect for further M&A activity as foreign
companies seek out corporate bargains in the UK.
As sterling fell, the FTSE 100 rose 0.9 percent on Friday.
The FTSE 250 was up 0.8 percent, underpinned by a surge in MAN
(Additional reporting by Patrick Graham, Dhara Ranasinghe and
Kit Rees; Graphic by Marc Jones; Editing by Tom Heneghan)