Gilts Gain as Growth, Euro-Area Debt Concern Spurs Haven Demand

U.K. government bonds rose for a second week as investors sought the safest assets amid concern global economic growth is slowing and the euro area’s sovereign-debt crisis is deepening.

The gains pushed the yields on two-year and 10-year gilts down to records. European Central Bank President Jean-Claude Trichet said Aug. 4 that policy makers will offer banks as much cash as they need for six months and extended existing liquidity measures. The pound rose for the second week versus the euro even as a report showed a U.K. manufacturing index fell to the lowest level in two years, while the Confederation of British Industry cut its economic growth forecast.

“Gilts are benefitting from the turmoil surrounding the euro-area debt crisis,” said John Wraith, a fixed-income strategist at Bank of America Corp.’s Merrill Lynch unit in London. “There’s a scramble for safe havens and concerns over slower growth in the U.K. and elsewhere. On a relative basis, gilts look better than ever, which underlines the importance of trying to get your fiscal house in order.”

The 10-year gilt yield fell 17 basis points in the week to 2.69 percent as of 5:00 p.m. yesterday, after reaching a record low 2.59 percent. Two-year gilt yields fell eight basis points to 0.55 percent after dropping as low as 0.51 percent.

The pound strengthened 1 percent against the euro to 86.73 pence. It reached 86.43 pence on Aug. 5, its strongest level since May 27. Sterling weakened for the first week in four versus the dollar, dropping 0.3 percent to $1.6375. The British currency reached $1.6476 on Aug. 1, the most since June 1.

Factory Output

A gauge of factory output fell to 49.1, the lowest level since June 2009, from 51.4 the previous month, a report by Markit Economics and the Chartered Institute of Purchasing and Supply showed on Aug. 1. A reading of less than 50 indicates contraction. The U.K. economy will expand 1.3 percent this year, compared with an estimate of 1.7 percent in May, the CBI said Aug. 1 in a quarterly forecast.

Sterling has fallen 7.2 percent in the past 12 months, making it the second-worst performer among 10 developed-market currencies, after the U.S. dollar, according to Bloomberg Correlation-Weighted Indexes. The U.K. currency weakened on concern the economic recovery was faltering amid the biggest budget squeeze since World War II as Prime Minister David Cameron cuts spending to reduce the deficit.

BOE Rates

Bank of England policy makers left the benchmark rate unchanged at 0.5 percent on Aug. 4, in line with the forecast of all 55 economists in a Bloomberg survey. Policy makers also kept their bond-purchase program, known as quantitative easing, on hold at 200 billion pounds ($328 billion).

“As expected, this is business as usual and a non-event for the market,” said Jane Foley, a senior foreign-exchange strategist at Rabobank International in London. “Inflation has still been too high for speculation of further QE this month. I expect this to change by the end of the year on the expectation that inflation will slow.”

Gilt yields may stay near their lows next week, according to Merrill Lynch’s Wraith. The Bank of England is scheduled to publish its quarterly inflation report on Aug. 10.

“The tone of the report may suggest the chance of more monetary easing in due course, which should be supportive for gilts,” Wraith said.

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