June 30 (Bloomberg) -- U.K. Independence Party leader Nigel Farage took his argument that Britain should leave the European Union to bond investors last week. To them, the risk of an exit is just one of the challenges facing the gilt market.
A rally handing government bonds their best first half since 2010 risks faltering as Britain faces an independence referendum in Scotland, a general election that could clear the way for a popular vote on leaving the EU, and the prospect of a Bank of England interest-rate increase as early as this year.
“There will probably be an uncertainty premium,” said Frances Hudson, an Edinburgh-based global thematic strategist at Standard Life Investments Ltd., which oversees about $64 billion of fixed-income assets. Both the Scottish and potential EU referendum “could have fairly severe implications for gilts,” she said.
Amid rising support for UKIP’s anti-EU stance, Prime Minister David Cameron has vowed to repatriate powers and hold an in-or-out referendum on U.K. membership of the 28-nation bloc in 2017 if his Conservative Party wins next year’s election.
Polls show Britons wanting to leave the EU outnumber those in favor of staying, and Cameron says the nomination of Jean-Claude Juncker -- seen in the U.K. as a bar to reform -- to run the European Commission has made it harder to keep Britain inside.
Farage, a former metals broker turned politician whose appearance at a Euromoney conference filled the ballroom at London’s Park Lane Hilton, had a message for investors concerned his party is nudging Britain closer to the EU exit.
“The whole point about political change is you see movements and changes in markets,” he said as he shook hands and paused for selfies with delegates at the June 25 event. “If bonds were utterly predictable for the rest of time, there wouldn’t be much bond trading, would there?” UKIP did not immediately respond to a request for comment.
UKIP beat Labour and the Conservatives to take 24 seats in the European Parliament in May 22 elections, and made sweeping gains in U.K. local-council polls.
The party, which has no seats in the House of Commons, is getting as much as 15 percent support in opinion polls, and much of its gain since 2010 has come at the expense of the Conservatives. Nationally, the Labour opposition leads the Tories by about 5 percentage points, leaving the outcome of the May 2015 election in the balance.
Similarly, doubts persist over the future of Scotland, where voters will decide Sept. 18 whether to split from the rest of the U.K. after more than 300 years of union.
Forty-three percent want to keep the U.K. intact and 36 percent favor breaking away, according to an ICM Research survey published June 15. There are still enough undecided voters to swing the outcome either way.
“There are always things that could buffet us,” Robert Stheeman, chief executive officer at Britain’s Debt Management Office, said in an interview. “Political events happen and the market has continued to function without a hiccup during that time. I don’t see why it shouldn’t in future.”
While the three main U.K. political parties have ruled out sharing the pound with an independent Scotland, the government has said it will honor all outstanding gilts.
Gilts -- with Norwegian bonds -- returned less than any other European sovereign debt market in 2014, gaining 3.7 percent. That compares with 4.7 percent for German bonds, according to indexes compiled by Bloomberg.
The two-year gilt yield climbed to a three-year high of 0.93 percent on June 17 after BOE Governor Mark Carney said the key interest rate may rise from a record low earlier than investors expected. The yield, which was at 0.86 percent at 12:44 p.m. London time, will climb to 1.91 percent by the end of the second quarter of 2015, according to a weighted average of analysts surveyed by Bloomberg.
The spread over equivalent German notes reached its highest since 2008 on June 16 after the European Central Bank cut borrowing costs to a record low to spur the euro-region economy.
“With the political backdrop, it’s very difficult,” said Simon Peck, a rates strategist at Royal Bank of Scotland Group Plc in London. “Along with the pricing of rate expectations at the short end, uncertainty means there needs to be risk premia priced in.”
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