Gilts Climb 17% in 2011, Beating Treasuries, Bunds Amid Europe Debt Crisis

U.K. government bonds rose for a fourth week, with two- and 10-year yields dropping to records, as investors sought safer assets after European Central Bank loans failed to soothe turmoil in euro-area debt markets.

Gilts completed a second year of gains, returning 17 percent on average and outperforming German bunds and U.S. Treasuries. Ten-year yields (GUKG10) fell yesterday to the lowest since Bloomberg started tracking them in 1989 as an industry report showing home prices declined added to signs the recovery is faltering. The pound completed a third yearly advance versus the euro after 15 European summits in two years failed to stop the debt crisis from spreading.

The outlook for gilts “really depends on what happens with the European situation,” said Vatsala Datta, an interest-rate strategist at Lloyds Bank Corporate Markets in London. “If we get something on a positive bent then we might see yields bounce back above two percent. But on relative terms, I think they will be supported against Treasuries and bunds.”

The 10-year yield (GUKG1O) fell six basis points, or 0.06 percentage point, this week to 1.98 percent after dropping to a record 1.932 percent. The 3.75 percent bond due in September 2021 gained 0.55, or 5.50 pounds per 1,000-pound ($1,552) face amount, to 115.54.

Two-year yields (GUKG2) declined one basis point to 0.33 percent, after falling to an all-time low 0.271 percent yesterday.

‘Systemic Stress’

U.K. bond yields have dropped every week since Standard & Poor’s put 15 euro nations on watch for a possible downgrade on Dec. 5, including AAA rated Germany and France. S&P said it placed the countries on review as “systemic stress in the euro zone has risen in recent weeks.”

Concern Italy will struggle to repay its debt pushed its 10-year yields above 7 percent this week, boosting demand for the safety of gilts. The Mediterranean nation raised less than its maximum target at an auction on Dec. 29, even after the European Central Bank provided banks with a record 489 billion euros ($635 billion) of three-year loans.

The 17 percent return from gilts this year is most since 1998, according to indexes compiled by the European Federation of Financial Analysts Societies and Bloomberg. German securities, Europe’s benchmark, gained 9.6 percent, Treasuries rose 9.8 percent, and Italian debt tumbled 5.7 percent, the indexes show.

Slowing Economy

Gilts were boosted yesterday as Nationwide Building Society said (UKNBAAMM) the average cost of a U.K. home fell 0.2 percent in December, the first monthly drop since August.

The Office for Budget Responsibility, Britain’s fiscal watchdog, cut its forecasts for economic growth last month to reflect the turmoil in Europe, the biggest market for U.K. goods sold abroad.

The deteriorating economic outlook has prompted the government to raise its planned gilt issuance for the 12 months through March by 6.8 percent to 178.9 billion pounds. The first sale of 2012 is an auction of five-year notes on Jan. 4.

The Bank of England (UKAPTARG) has supported the economy and the bond market with 249 billion pounds of gilt purchases (UKAPGPT), so-called quantitative easing, since March 2009. The ECB has failed to replicate such measures in the euro zone.

“Bunds are under threat because Germany may be the ultimate payer for the other countries,” Lloyds’s Datta said. “On a relative basis, prospects of further QE in the U.K. will keep gilts supported.”

The pound has strengthened 2.6 percent against the euro this year as the crisis weighed on the 17-member currency. Sterling rose 0.2 percent to 83.57 pence per euro this week.

The U.K. currency weakened 0.3 percent this week to $1.5536, and dropped 1.7 percent to 119.64 yen.

Sterling was little changed in 2011 according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-nation currencies. The yen was the best performer, gaining 5.2 percent and the dollar appreciated 0.9 percent.

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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