U.K. 10-Year Gilt Yields Reach Three-Week High as Services Grow

U.K. government bonds fell, pushing 10-year yields to a three-week high, as a report showed services grew faster than economists forecast in May, bolstering the case for higher Bank of England interest rates.

Two-year gilts fell for a fifth day, the longest streak since March 10. Ten-year gilts underperformed their German counterparts amid speculation the U.K. central bank will keep borrowing costs at a record low tomorrow and the European Central Bank will add stimulus to boost inflation and economic output in the 18 nations that share the euro.

“Gilt yields look quite low given the health of the domestic economy right now,” said Shahid Ladha, head of U.K. strategy at BNP Paribas SA in London. “There’s still room for further gilt-bund underperformance in the third quarter.”

The 10-year gilt yield rose six basis points, or 0.06 percentage point, to 2.70 percent at 4:33 p.m. London time after climbing to 2.71 percent, the highest since May 13. The 2.25 percent bond due September 2023 fell 0.44, or 4.40 pounds per 1,000-pound ($1,677) face amount, to 96.32. Two-year rates climbed two basis points to 0.71 percent.

Markit Economics said the U.K. economy “continued to boom” last month as its purchasing managers’ index for the services industry came in at 58.6, exceeding the 58.2 median of analyst estimates in a Bloomberg News survey. That’s above the 50 level that divides expansion from contraction and compares with a reading of 58.7 in April.

Accelerating Growth

Ten-year yields have increased from a 2014 low of 2.52 percent on May 29, amid speculation accelerating growth will prompt Bank of England policy makers, who begin their two-day meeting today, to start raising interest rates. Economists in Bloomberg surveys predict officials will raise borrowing costs by the first quarter of next year.

The extra yield, or spread, that investors receive for holding 10-year gilts instead of similar-maturity bunds increased three basis point to 127 basis points, the most since May 12 based on closing-prices data.

All but two of 60 economists surveyed by Bloomberg forecast ECB policy makers will cut the benchmark rate from a record-low 0.25 percent tomorrow. The ECB will also lower its deposit rate below zero, according to most analysts in a separate survey before officials gather in Frankfurt.

Gilts Returns

Gilts have earned 0.5 percent in the last three months, less than half the 1.2 percent return on German bonds, reflecting the divergence in the growth prospects of the U.K. and the euro area, according to Bloomberg World Bond Indexes. Treasuries also gained 0.5 percent as the Federal Reserve reduces its stimulus for the U.S. economy.

The British Chambers of Commerce last week raised its growth forecast for the U.K., and sees 3.1 percent expansion this year versus a previous estimate of 2.8 percent. The group said gross domestic product will surpass its pre-recession peak this quarter and raised its growth forecast for 2015 to 2.7 percent from 2.5 percent.

The pound was little changed at $1.6747 after sliding to $1.6699, the weakest since May 29. It was also little changed at 81.29 pence per euro.

Sterling has jumped 9.3 percent in the past 12 months, the best performer among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Currency Indexes. The euro rose 3.5 percent, while the dollar slipped 1 percent.

To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Mark McCord

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