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Gilts Advance on Bets Bank of England Will Increase Purchases

U.K. government bonds rose this week, pushing two-year yields down by the most in more than a month, on speculation the Bank of England will buy more debt after a report showed the economy is edging toward recession.

Sterling fell for a third week against the euro as European officials said negotiations over a Greek debt swap are leading to an agreement. Minutes from the central bank’s latest policy meeting, published on Jan. 25, showed some policy makers say more stimulus is “likely.” The U.K. economy contracted 0.2 percent from the third quarter, twice the median estimate in a Bloomberg survey, the Office for National Statistic said on the same day.

“The U.K. economic outlook has deteriorated and that supports a market view that the Bank of England will provide further stimulus,” said Richard McGuire, a senior fixed-income strategist at Rabobank International in London. “The uncertainty surrounding the Greek debt talks also underpins demand for AAA assets. Gilts should continue to do well in this environment.”

The yield on the 10-year gilt fell five basis points, or 0.05 percentage point, from Jan. 20, to 2.07 percent as of 4:31 p.m. London time yesterday. Two-year note yields declined three basis points, the biggest drop since the five days ending Dec. 16. Thirty-year yields were little changed at 3.12 percent.

The pound fell 1 percent from last week to 83.90 pence per euro and declined 0.4 percent to 120.39 yen. It rose 0.7 percent to $1.5692. Sterling dropped 1.3 percent so far this year, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-nation currencies. The dollar declined 2.3 percent and the euro lost 0.6 percent.

Gilt Sales

Yields may rise next week before the Debt Management Office sells 3.75 billion pounds of gilts. The debt agency plans to auction 2.5 billion pounds of 5 percent bonds maturing in 2025 on Feb. 1, and offer 1.25 billion pounds of a 0.125 percent index-linked security due in 2029 the next day.

The Bank of England’s current round of bond purchases under its quantitative easing program will end this month. Governor Mervyn King said on Jan. 24 that slower inflation gives policy makers room to increase bond purchases to guard against a “renewed severe downturn.” His view was echoed in minutes of the January policy meeting published the next day.

‘Inflation Target’

U.K. consumer-price inflation slowed to an annual 4.2 percent in December, from a record-equaling 5.2 percent in September. The Bank of England aims to keep annual price increases below 2 percent.

“For some members, the risks of undershooting” the inflation target “meant that a further expansion of asset purchases was likely to be required,” the central bank said in the minutes of its Jan. 11-12 meeting. “But there was no compelling need to increase the scale of the program before completing those already announced.”

Gilts underperformed Treasuries this week as the Federal Reserve extended its pledge to keep interest rates low until late 2014 and signaled it may buy more bonds to cap borrowing costs. The extra yield investors demand for holding 10-year U.K. government debt instead of its U.S. counterpart rose to 14 basis points from nine basis points last week.

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