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U.K. Two-Year Yield Drops to Record on Euro-Area Rating Concern

U.K. 10-year gilts gained the most in three weeks and two-year yields dropped to a record after Standard & Poor’s said Germany and France may be downgraded as policy makers remain divided on how to solve the region’s crisis.

Thirty-year yields slid as reports showed U.K. retail sales fell the most in six months in November and house prices declined, while demand picked up at a sale of the securities. Sterling weakened against the dollar and the yen as investors sought a haven after S&P put the region’s six AAA rated countries on negative outlook, pending the outcome of a European Union leaders’ summit on Dec. 8-9. Such downgrades may result in the European Financial Stability Facility, a bailout fund, to also lose its top credit, S&P said separately.

“Gilts outperformed bunds today because the U.K. is not in the euro zone,” said Marc Ostwald, a fixed-income strategist at Monument Securities in London. “The U.K. may not be in a fantastic place, but in relative terms, some people see it as a safe haven with what’s going on in Europe.”

The 10-year gilt yield fell 10 basis points, or 0.10 percentage point, to 2.25 percent at 4:57 p.m. London time, the biggest one-day drop in yields since Nov. 14. The 3.75 percent securities due September 2021 rose 0.920, or 9.20 pounds per 1,000-pound ($1,561) face amount, to 113.080. Two-year yields fell two basis points to 0.37 after touching a record low 0.351 percent.

The yield spread between 10-year gilts and equivalent-maturity German bunds narrowed by eight basis points to 0.08 percentage point.

Coupon Payments

Gilts have returned 14 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bonds gained 7.2 percent during the same period, the indexes show.

U.K. government bonds were also supported on speculation investors will reinvest coupon earnings due tomorrow, Ostwald said. The payments total 7.37 billion pounds, according to the Debt Management Office.

French and German bonds fell after the warning from Standard & Poor’s. The yield on French 10-year debt rose 11 basis points to 3.24 percent with the yield on similar-maturity bunds climbing by as much as six basis points to 2.27 percent before trading two basis points lower 2.19 percent.

European Central Bank President Mario Draghi will probably cut the benchmark interest rate a quarter point to buoy the economy when policy makers meet Dec. 8, according to the median of 58 economist estimates in a Bloomberg survey.

Repo Facility

The pound was 0.4 percent weaker to $1.5581 and lost 0.5 percent to 121.12 yen. Sterling was down 0.4 percent at 85.96 pence per euro.

“The dollar is outperforming the pound in a risk-off environment,” said Jane Foley, a senior currency strategist at Rabobank International in London. “That’s affected other currency crosses including the euro versus the pound.”

Sterling has fallen 3.6 percent in the past 12 months, making it the worst performer among 10 developed-market peers measured by Bloomberg Correlation-Weighted Indexes.

Two-year notes briefly pared gains after the Bank of England introduced a new facility to provide market liquidity to address potential strains in financial markets.

The Extended Collateral Term Repo will provide funding against the widest range of collateral, the London-based central bank said in an e-mailed statement today. The operations will offer sterling for 30 days against collateral currently allowed for use in the bank’s Discount Window Facility.

Euro Crisis

Thirty-year gilts extended gains after demand picked up at an auction of the 4.25 percent bond maturing in 2040. The sale today drew bids 1.98 times the amount of securities of offer, compared with a bid-to-cover ratio of 1.95 times at a previous sale in July. The average accepted price rose to 117.92 from 101.25. The yield on 30-year gilts fell 13 basis points to 3.19 percent.

U.K. house prices dropped 0.9 percent from October, when they rose 1.2 percent, Halifax, the mortgage unit of Lloyds Banking Group Plc, said today.

The euro crisis may further hurt the U.K. economy, according to ING Bank. The country’s output would fall more than 9 percent and the pound could rise 25 percent on a trade-weighted basis if the 17-nation euro area breaks up, it said.

“Given the level of trade and the scale of financial linkages with the euro zone, such an outcome would have grave consequences for the U.K.,” London-based ING economist James Knightley said in an e-mailed note to clients.

The DMO today said it will hold 13 gilt auctions in the three months from January through March. It may sell long-dated conventional gilts through banks in January and long-dated index-linked bonds in the same way in February, the debt agency said in the minutes of its meeting yesterday with primary dealers and investors.

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