World-Beating Gilts Boost Pound as Cameron Austerity Meets With King Ease
The pound is turning into the must- have currency for investors seeking to get in on the world’s biggest government-bond rally.
After weakening in the first half of the year, sterling has gained against all 16 major currencies tracked by Bloomberg except the yen. U.K. gilts have generated a return of 10.8 percent in 2011, the biggest among 26 sovereign-debt markets measured by Bloomberg/European Federation of Financial Analysts Societies indexes.
The combination of Prime Minister David Cameron’s fiscal austerity and Bank of England Governor Mervyn King’s efforts to bolster the economy with record-low interest rates and bond purchases are attracting investors seeking a haven from Europe’s debt crisis and political gridlock in the U.S. Reserves invested in pounds rose 12 percent in the first half, compared with a 9.6 percent gain for the euro and a 3.5 percent increase in the dollar, the International Monetary Fund in Washington said.
“There is a lot of flow going into the U.K. from foreign investors, Middle East, China,” Mitul Kotecha, head of global currency strategy in Hong Kong at Credit Agricole Corporate & Investment Bank, said in an interview on Oct. 26. “There was a view that if we had QE2, it would weaken sterling, but the markets are also rewarding proactive policy,” he said, referring to the Bank of England’s second round of bond purchases, or quantitative easing.
The pound has strengthened 2.2 percent from its low this year on June 30 against a basket of nine developed-nation peers measured by Bloomberg Correlation-Weighted Indexes. The dollar has risen 2.1 percent in the period, while the euro has weakened 1.8 percent, the indexes show.
Against the dollar, the pound jumped 1.1 percent last week to $1.6130, a third-straight weekly advance, while it depreciated 0.7 percent to 87.75 pence per euro. It was little changed at $1.6123 at 1:00 p.m. New York time, and strengthened 1.6 percent to 86.36 pence per euro.
Kotecha said he favors buying sterling against Europe’s 17- nation common currency, anticipating it will appreciate to 83 or 84 pence per euro over the next six months.
“The U.K. has a plan and it’s sticking to it,” Howard Cunningham, a London-based director of investment management at Newton Investment Management Ltd., which oversees 47 billion pounds ($75 billion), said in an interview on Oct. 20. Britain is an “oasis of calm,” he said.
Cameron, 45, wants to erase Britain’s structural deficit by 2015, mirroring policies that made Germany Europe’s safest debt market. The U.K.’s outlays exceeded revenue by 63.5 billion pounds in the six months through Sept. 30, shrinking from 71 billion a year earlier, and on course for the target of cutting borrowing by 15 billion pounds of cuts in the year through March, the government said on Oct. 21.
The U.K.’s strategy contrasts with the U.S., where a congressional supercommittee seeking at least $1.2 trillion in deficit cuts remains deadlocked over Democrats’ insistence on tax increases. Unlike the U.S., downgraded to AA+ by Standard & Poor’s on Aug. 5, the U.K. is ranked AAA by the three main credit-rating firms.
In the euro area, Greece’s inability to contain its debt load has left the nation’s bondholders facing a 50 percent writedown on their investments, while rising borrowing costs across the region pushed leaders to step up crisis-fighting measures last week. Lawmakers said they will boost the firepower of an existing rescue fund to 1 trillion euros ($1.4 trillion) and recapitalize banks to end the turmoil that broke out in Greece two years ago.
The region faces “a crisis of confidence” that risks turning away investors, German Chancellor Angela Merkel said in an Oct. 28 speech to members of her Christian Democratic Union party. “We’re not going to get rid of that in a day, with one big bang, or in a year,” she said of the region’s crisis.
The U.K.’s Conservative-led coalition government is resisting opposition Labour Party demands for more spending. A policy reversal would risk driving up borrowing costs, Chancellor of the Exchequer George Osborne said during a debate in Parliament on Oct. 12.
“It’s because we’ve got a credible plan that we’re pulling the country out of this economic mess,” he said. “Low interest rates are a precious commodity for the United Kingdom at the moment. Do we really want to see an increase in interest rates at this time?”
Ten-year gilt yields fell to a record 2.18 percent on Sept. 12, from 3.40 percent on Dec. 31 and more than 5.5 percent in 2007. They fell 17 basis points to 2.44 percent today.
The year-to-date return for gilts compares with 6.2 percent for German bonds and 7.3 percent for U.S. Treasuries, the Bloomberg/EFFAS indexes show.
The U.K. economy will expand 1.3 percent next year, compared with 0.9 percent in 2011, according to the median of economist estimates compiled by Bloomberg. The euro region’s growth will slow to 0.7 percent from 1.6 percent, while the U.S. will accelerate to 2 percent from 1.7 percent, surveys show.
King, 63, is supporting growth and demand for bonds by keeping the central bank’s benchmark interest rate at a record low 0.5 percent and employing a bond-buying strategy similar to the Federal Reserve’s quantitative easing to pump money into the economy. At the same time, U.K. inflation has accelerated, with consumer prices rising 5.2 percent from a year earlier in September, matching a record high.
U.K. policy makers decided to increase asset purchases by 75 billion pounds to 275 billion pounds at their last meeting on Oct. 6. The Fed has bought about $2.3 trillion of government and mortgage-related bonds the past three years. European Central Bank President Jean-Claude Trichet has avoided quantitative easing and overseen two interest-rate increases for the euro area this year to 1.5 percent.
The pound has gained about 5 percent against the dollar since touching its lowest level for the year on Oct. 6, when the Bank of England announced its plan.
The U.K. asset purchases may yet weigh on sterling as they increase supply of the currency, according to Shaun Osborne, chief currency strategist at Toronto-Dominion Bank’s TD Securities unit in Toronto.
“We can’t really rule out at the moment further easing coming through,” he said in a phone interview on Oct. 27. “It’s going to keep the pound toward the lower end of the range that it has been in the past couple of months.”
The pound will stay little changed against the euro, trading at 87 pence at year-end, and weaken to $1.56, according to median analyst estimates compiled by Bloomberg.
Sterling’s strength marks a turnaround from much of the past four years. It has depreciated 30 percent as measured by Bloomberg Correlation-Weighted Indexes since the end of 2006. The currency suffered as the government added to its deficit by spending 65.8 billion pounds bailing out Lloyds Banking Group Plc (LLOY) and Royal Bank of Scotland Group Plc.
Britain’s government debt was 79.9 percent of gross domestic product last year and its deficit was 10.3 percent of the economy, according to European Union data. While Germany’s debt ratio was 83.2 percent, its deficit was 4.3 percent of GDP. Spain’s deficit was 9.3 percent of GDP and Ireland’s was 31.3 percent.
“At the beginning of last year we were like Spain, and we risked being like Ireland,” Newton’s Cunningham said of the U.K. “Over the course of the next 12 months we were like France. Now we’re heading in the direction of Germany, while France is heading the other way.”
Germany’s 10-year borrowing costs were 43 basis points less than Britain’s at the end of last week. France paid 55 basis points more than the U.K. to borrow for the same period.
Britain’s relatively small current-account deficit, which narrowed to 2 billion pounds in the second quarter, the least since the start of 2008, means the nation doesn’t need to rely as much as the U.S. on foreign capital, making it a haven for currency investors. The broadest measure of trade in the U.S. equals 3.1 percent of the economy, compared with 1.8 percent in the U.K.
Non-resident holdings of gilts increased by 25.7 billion pounds this year through Sept. 30, after rising by 78.7 billion pounds last year, according to Bank of England data. They increased by 12 billion pounds in September, the most since April 2010. The pound’s share of global currency reserves rose to 4.2 percent in the second quarter from 4 percent at the end of last year, the latest data from the IMF in Washington show.
DWS Investment GmbH, which manages about $400 billion, sees the pound rising to a range of $1.63 to $1.64 by year-end, according to Dirk Aufderheide, head of currencies at the firm in Frankfurt.
“Sterling represents an interesting currency for diversification because it’s liquid,” Aufderheide said in an Oct. 26 telephone interview. “Cameron and his team were able to implement very strong measures and that’s what the market loves.”
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