May 1 (Bloomberg) -- Shorter-maturity U.K. government bonds are yielding more relative to their longer-dated peers than at any time since July, a sign traders are betting the fastest-growing developed economy is likely to gather momentum.
Speculation the Bank of England will raise borrowing costs as soon as this year is leading investors to shun short-term securities. The extra yield demanded to hold 10-year gilts instead of two-year debt has fallen 49 basis points, or almost half a percentage point, this year to 196 basis points.
Britain is just short of its pre-financial crisis level of output after the economy grew for a fifth-straight quarter between January and March, and surveys point to growth strengthening. Derivatives known as Sonia contracts signal the central bank will raise its benchmark rate from a record-low 0.5 percent within a year.
“We think rate hikes will come much earlier than anticipated and that should keep up the bearish bias in the front end of the curve,” Jamie Searle, a U.K. rates strategist at Citigroup Inc. in London, said in an interview on April 29. “Surveys suggest the economy is still picking up at a strong pace. The underlying trend is one of growth.”
The first rate increase could come as soon as November, Searle said. A yield curve is a chart showing rates on bonds of different maturities.
U.K. securities maturing in one to three years returned 0.31 percent this year, according to Bank of America Merrill Lynch indexes. That compares with a 4.7 percent return for gilts maturing in 10 to 15 years. The gap between two-year and 10-year yields is projected to be 217 basis points by year-end, based on the median of yield forecasts in a survey compiled by Bloomberg.
The economy’s 0.8 percent expansion in the first quarter left gross domestic product just 0.6 percent below its level in early 2008 before the financial crisis plunged Britain into its worst recession since World War II. The International Monetary Fund predicts the U.K. will expand faster than any other Group of Seven nation this year, with growth of 2.9 percent.
U.S. data yesterday showed the American economy barely grew in the first quarter as harsh winter weather curbed spending.
GfK NOP Ltd. said yesterday U.K. consumer confidence rose to the highest in almost seven years last month. A manufacturing index rose to 57.3 from 55.8 in March, Markit Economics said today. That’s above the median estimate of 32 economists in a Bloomberg News survey for a reading of 55.4. A level above 50 indicates expansion.
While short-maturity debt is under pressure, longer-dated gilts are offering a haven for investors concerned the crisis in Ukraine will escalate. The U.S. and the European Union this week expanded sanctions against Russia, which annexed Crimea in March and is accused of aiding separatists in eastern Ukraine.
“There’s an element of flight to safety keeping bond yields lower,” David Tan, head of rates at J.P. Morgan Asset Management in London, said in an April 29 interview. “Gilts and Treasuries have traded with a very high correlation. Geopolitics have kept yields down.”
Benchmark 10-year gilt yields have fallen 38 basis points this year to 2.64 percent as of 4:22 p.m. London time today, while Treasury yields are down 41 basis points to 2.62 percent. U.K. government bonds returned 3.1 percent this year through yesterday, Bloomberg World Bond Indexes show. German securities earned 3.2 percent and U.S. Treasuries gained 2.4 percent.
Also helping 10-year yields is the assurance of BOE officials that interest rates won’t return to the levels of about 5 percent seen before the financial crisis. Any rate increases will be “gradual” and “limited,” Governor Mark Carney told lawmakers March 11.
“We buy into the bank’s view,” Tan said. “From that point of view the curve can keep flattening. I don’t see 10-year gilts trading much above 3 percent.”
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