U.K. Bonds Fall Most This Year as Gilts Underperform Euro Peers

U.K. government bonds had a weekly drop, with 10-year yields rising the most this year, as gilts underperformed most euro-area peers amid a strengthening British economy and mounting speculation interest rates will rise.

The decline sent the yield premium over German bunds to the widest since before the euro’s debut in 1999 and that over French securities to the most in more than eight years. Spreads widened after the European Central Bank cut borrowing costs this week while the BOE kept its policy on hold as it debates when to lift rates. The pound advanced against the dollar and euro as the BOE also maintained its program of asset purchases.

“The case for U.K. gilts to underperform their euro-area peers is likely to continue for the time being,” said Richard Kelly, a senior strategist at Toronto-Dominion Bank in London. “The trend will only reverse if the Bank of England becomes dovish, which is unlikely, or if the economic growth in the euro zone picks up at a pace that would make quantitative easing unnecessary.”

The U.K. 10-year gilt yield rose nine basis points, or 0.09 percentage point, in the week to 2.66 percent as of 5 p.m. London time yesterday. The 2.25 percent security due September 2023 tumbled 0.69, or 6.90 pounds per 1,000-pound ($1,679) face amount since May 30, to 96.7. The weekly gain in yields was the most since the five days through Dec. 27.

German Spread

The extra yield that investors get for holding the U.K. securities instead of German bonds due in 10 years rose nine basis points this week and reached 130 basis points yesterday, the widest since before the euro’s introduction in 1999, based on closing prices. The spread over French securities was 95 basis points, the most since October 2005.

Returns on gilts this year trailed those on euro-area peers by an average 2.7 percentage points, earning 3.32 percent compared with 6.06 percent for the nations that share the euro, according to Bloomberg World Bond Indexes.

A growing U.K. economy has spurred bets the BOE will hasten plans to raise rates, while the threat of deflation in the euro prompted the ECB to expand stimulus.

The nine members of the Bank of England’s Monetary Policy Committee in London left the benchmark interest rate at 0.5 percent on Thursday, while keeping asset purchases under the quantitative easing program at 375 billion pounds. The ECB in Frankfurt cut the refinancing rate to a record-low 0.15 percent and also set its deposit rate at less than zero.

The U.K. is scheduled to sell 8.15 billion pounds of bills and bonds next week. Government reports will show that industrial production grew at a faster pace in April and unemployment declined, according to Bloomberg surveys of economists.

The pound appreciated 0.2 percent this week to 81.21 pence per euro. Sterling also gained 0.2 percent to $1.6793 after reaching $1.6845 yesterday, the strongest since May 27.

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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