Gilts recoup losses after PPI, stocks ease Bank woe

LONDON (Reuters) - Gilt futures recovered from heavy early losses on Friday to gain slightly on the day, after weak producer prices and falling shares undid some damage from the Bank of England's decision to slow gilt purchases.

At 12:39 p.m., the September long gilt future was 8 ticks higher at 117.43 after being almost a full point lower earlier in the session at 116.53, a level last seen on June 19.

"We had some fairly soft producer prices data, but also we had oversold very heavily yesterday. Now we're tracking Bunds, and the stock market's off a bit," said Moyeen Islam, gilts strategist at Barclays Capital.

British producer prices fell at their fastest pace in seven-and-a-half years in June, data from the Office for National Statistics showed on Friday, pointing to a sharp fall in consumer price inflation in the coming months.

The FTSE-100 share price index was down 0.75 percent, giving further support to fixed income.

Short sterling futures gained strongly, with the September 2010 contract leading the strip up 8 ticks, reversing most of Thursday's losses, as traders reassessed bets that the BoE decision to slow quantitative easing brought interest rate rises much nearer.

"The initial view people were taking was that if you're at the end of the QE process, it takes you one step closer to the first rate hike. That's why short sterling was selling off. But fundamentally it was looking pretty cheap and people realised the sell-off had overshot a little bit," Islam said.

On what was previously the hardest-hit segment of the cash market, 10-year yields were level on the day at 3.77 percent after rising 18 basis points on Friday, keeping the spread over Bunds near its widest for four months at 52 basis points.

Two-year yields were 4 basis points lower at 1.15 percent.