Gilts Rally on Speculation BOE Ready to Restart QE

Gilts rallied, pushing two-year note yields toward a record low, on speculation the Bank of England will buy more government bonds to support the economy as Europe’s debt crisis deepens.

Investors increased bets that borrowing costs will fall, sending implied yields on short-sterling futures to contract lows. Central bank Governor Mervyn King announced joint steps with the Treasury to increase the flow of credit to U.K. and said the case for more stimulus is “growing.”

“The central bank eased the criteria on which banks can access liquidity from it, and at lower rates,” said John Wraith, an interest-rate strategist at Bank of America Merrill Lynch in London. “These measures have led to a sharp drop in implied rates. Gilt yields dropped as expectations of more bond buying have strengthened.”

The yield on the two-year note fell six basis points, or 0.06 percentage point, to 0.22 percent at 4:55 p.m. London time. It fell to 0.193 percent, approaching the record low of 0.189 percent reached on June 1. The 2.25 percent security due March 2014 rose 0.1, or 1 pound per 1,000-pound ($1,563) face amount, to 103.485.

Ten-year yields dropped six basis points to 1.67 percent.

“I will be a seller of sterling against the dollar,” said Jeremy Stretch, head of currency strategy at the Canadian Imperial Bank of Commerce in London. “These measures may arguably help the economy in a longer run, but in the near term there will be more supply of sterling into the market.”

Monthly Injection

The Bank of England’s liquidity plan will see it inject at least 5 billion pounds a month into the financial system. A separate program will allow lenders to swap assets with the central bank in return for money to be loaned to companies and households. The Treasury said a 5 percent increase in lending would inject about 80 billion pounds into the economy.

Barclays Plc economist Simon Hayes said today that the central bank will boost its bond-purchase plan by 50 billion pounds next month to shelter Britain from financial woes in the euro area.

Gilts handed investors a 1.4 percent gain this year, compared with a 2.6 return from German bonds and 1.7 percent from Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analyst Societies.

Greeks go to the polls on June 17 for the second time in two months after an inconclusive May 6 vote deepened concern Greece will leave the 17-nation euro currency bloc.

Euro Turmoil

With the euro-area turmoil pushing up funding costs and making it harder to access credit, King said the lending plan will provide banks with funds below current market rates. This will be linked to their performance “in sustaining or expanding their lending to the U.K. non-financial sector during the present period of heightened uncertainty,” he said.

The implied yield on the short-sterling futures contract expiring in December fell 22 basis points to 0.60 percent, a contract low based on closing-market rates. The measure is used by analysts to gauge the trajectory of borrowing costs between banks. The implied yield on the June 2013 contract declined 18 basis points to 0.59 percent.

The difference between two-year swap rates and the comparable gilt yield, known as a swap spread, which is perceived as a measure of stress in the financial system, dropped to 70 basis points, the lowest since December last year.

Borrowing Costs

The liquidity moves were announced after record-low official interest rates and a so-called quantitative easing program failed to bring down borrowing costs that lenders charge to companies and households. The central bank has said the turmoil in the euro area, Britain’s largest trading partner, poses the biggest risk to the economy and financial stability.

Royal Bank of Scotland Plc, Lloyds Banking Group Plc and Barclays Plc shares all jumped more than 4.5 percent on the announcement, pushing a gauge of U.K. banks to a one-month high.

The pound rose 0.6 percent to $1.5656, the highest since May 29. It was 0.6 percent stronger at 81.69 pence per euro after weakening by as much as 0.4 percent to 81.53 pence.

The U.K. currency has dropped 2.5 percent in the past month, the worst performance among 10 developed-nation currencies, according to Bloomberg Correlation-Weighted Indexes. It’s declined as traders added to bets that the central bank will create additional money and buy bonds to boost the economy. The euro fell 1 percent in the period.

The rate that London-based banks say they pay for three- month loans in sterling fell to 0.951 percent today, according to the British Bankers’ Association. That’s the lowest since Sept. 29.

The London interbank offered rate, or Libor, for such loans compares with 0.99 percent yesterday, the BBA data showed.

To contact the reporter on this story: Anchalee Worrachate at aworrachate@bloomberg.net

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