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U.K. 10-Year Break-Even Rates Widen Most in Month After Auction

U.K. 10-year break-even rates widened the most in almost a month on increased demand for inflation-linked gilts as the nation sold 1.5 billion pounds ($2.4 billion) of the securities due in 2024.

The pound strengthened for a second day against the dollar. Bank of England Monetary Policy Committee member Martin Weale said the U.K. could face a triple-dip recession, the Daily Mail reported, citing an interview. A consultation on potential changes to the formula used to calculate Britain’s retail-price index has led to market concern about the impact on inflation-linked gilts, Robert Stheeman, chief executive officer of the U.K.’s Debt Management Office, said on Sept. 26.

“It was a strong auction,” said Sam Hill, a fixed-income strategist at Royal Bank of Canada in London. The result “was a relief as with the RPI methodology change issue hanging over the market there was a chance participation could have suffered.”

The U.K. 10-year break-even rate, a gauge of market inflation expectations derived from the yield difference between regular and index-linked bonds, was 11 basis points, or 0.11 percentage point, higher at 2.60 percent as of 4:18 p.m. London time, the biggest increase since Sept. 14. It fell to 2.39 percent on Oct. 3, the lowest level since Aug. 7.

The U.K. sold the 2024 inflation-linked gilts at an average real yield of minus 0.441 percent. Investors bid for 2.56 times the securities allotted. The nation has now sold 100.97 billion pounds of debt since April 1, according to the DMO. That represents 61.4 percent of its 2012-2013 fiscal year target of 164.4 billion pounds, according to data provided by the DMO.

‘Sufficient Evidence’

While index-linked government debt is tied to retail prices, the Bank of England sets its benchmark interest rate based on consumer-price inflation, which has been lower than retail-price inflation on average for the past two decades. The independent Consumer Prices Advisory Committee said on Sept. 18 there is “sufficient evidence to consider change” to inflation calculations and it’s examining “any unjustifiable formula effect gap” between the two measures.

Pacific Investment Management Co.’s Michael Amey said on Sept. 26 that Britain’s review of its retail-price index calculations could threaten the gilt market’s reputation as a haven for investors.

Conventional gilts declined after Standard & Poor’s yesterday cut Spain’s sovereign-debt rating to one level above non-investment grade, citing mounting economic and political risks as the Spanish government considers a second bailout.

Gilt Yield

The 10-year gilt yield was two basis points higher at 1.79 percent. The 1.75 percent bond due September 2022 fell 0.185, or 1.85 pounds per 1,000-pound face amount to 99.67.

Gilts returned 2.9 percent this year through yesterday, as investors bought the securities as a refuge from Europe’s debt crisis, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bonds gained 3.1 percent and U.S. Treasuries rose 2.1 percent.

Signs of recovery in the U.K. remain elusive, Bank of England policy maker Weale said in an interview with the Daily Mail, according to the newspaper. An increase in the central bank’s asset-purchase program, a policy known as quantitative easing, could push inflation higher, he said.

The Bank of England refrained from boosting its bond-buying target from 375 billion pounds at a policy meeting on Oct. 4. The central bank last increased its target in July, adding 50 billion pounds to the program, which is scheduled to end in November. Minutes of the meeting will be released on Oct. 17.

Sterling Gains

Sterling gained 0.1 percent to $1.6028, after dropping to $1.5977 yesterday, matching the lowest since Sept. 10. The pound weakened 0.3 percent to 80.67 pence per euro. It gained 0.6 percent in the past two days after reaching 81 pence on Oct. 9, the weakest level since Sept. 17.

The pound has strengthened 0.3 percent in the past six months, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-market currencies. The euro fell 2.1 percent and the dollar weakened 0.6 percent.

New York-based S&P said in a statement yesterday it lowered Spain’s credit ranking two levels to BBB- from BBB+. The ratings company maintained a negative outlook to the nation’s long-term rating, that it said “reflects our view of the significant risks to Spain’s economic growth and budgetary performance, and the lack of a clear direction in euro-zone policy.”

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