Aegon Asset Management is sticking with U.K. bonds because it expects the Bank of England to raise interest rates more slowly than the European Central Bank, even as inflation runs at almost twice the pace of the euro area.
Dutch insurer Aegon NV’s fund-management unit prefers gilts to German bunds, said Stephen Jones, who is responsible for 25 billion pounds ($40 billion) as co-head of fixed income. U.K. policy makers may start raising interest rates in May, though he said the increases may already be reflected in the price of gilts, which have declined in five of the past six months.
“We are content holders of gilts, particularly when compared with other European assets,” Jones said in an interview at the company’s Edinburgh headquarters. “At the moment, we are quite happy to be long gilts.”
While U.K. bonds have lost 0.7 percent this year, bunds have declined 2.1 percent, according to indexes from Bank of America Merrill Lynch. The extra yield investors demand to hold 10-year gilts instead of comparable bunds has dropped 14 basis points since March 2, the day before ECB President Jean-Claude Trichet said policy makers may raise borrowing costs.
The ECB’s main refinancing rate is double the Bank of England’s benchmark rate of 0.5 percent. ECB officials signaled their intentions to increase interest rates to contain an inflation rate that quickened to 2.6 percent in March, the fastest in more than two years, from 2.4 percent in February.
Bank of England Governor Mervyn King said earlier this month raising rates too soon would be a “futile gesture.” At the same time, U.K. consumer prices rose 4.4 percent in February, more than twice the central bank’s 2 percent target.
While King “will have to react to these inflation numbers by moving away from the emergency level” of rates, “we don’t see that as being a rout,” Jones said. “The view coming out from Trichet and the council is very hawkish,” he said.
Investment strategists at Aegon, Scottish Widows Investment Partnership, Standard Life Investments and Aberdeen Asset Management Plc all said last week that the biggest risk to markets is governments and central banks getting it wrong on spending cuts and interest rates.
The Bank of England has held its benchmark rate at a record low since March 2009. Analysts surveyed by Bloomberg expect the cost of borrowing to rise to 1 percent in the fourth quarter of this year. They expect the ECB in Frankfurt to push its main refinancing rate to 1.75 percent from 1 percent by the end of the year, according to estimates.
The move by the Bank of England will be “gentle and it is already largely priced into fixed-income assets in the U.K.,” Jones said. “Gilts are able to look through some of the inflationary pressure and have done over the last couple of months,” he said on March 23.
Scottish Widows Investment, manager of 68 billion pounds of bonds from Edinburgh, said this month that gilts will decline further as investors bet interest rates will increase. Mark Connolly, head of fixed income, said the company remained “some way from being long gilts.”
The yield on the 10-year gilt declined 2 basis points to 3.65 percent today in London. That’s up 14 basis points, or 0.14 percentage point, from 3.51 percent at the end of 2010.
Standard Life said last month U.K. government bonds will start to recover as investors realize interest rates will stay lower for longer. Too many increases in borrowing costs were being priced into the market, said Euan Munro, who runs about 65 billion pounds at the company, on Feb. 10.
Gilts returned 0.8 percent in February, after falling in each of the previous five months, the Bank of America Merrill Lynch indexes showed.
Aegon’s U.K. fund business oversaw 41 billion pounds in total from Edinburgh on Dec. 31, up 14 percent from a year earlier. Aberdeen, Scotland’s largest money manager, increased assets 27 percent to 183 billion pounds in 2010, while Standard Life’s funds went up 13 percent to 157 billion pounds and they rose 3.2 percent to 146 billion pounds at Scottish Widows.