Carney More Bearish Than Gilts Losing Out to Bunds: U.K. Credit
U.K. government bonds show that investors are more positive on the British economy than new Bank of England Governor Mark Carney.
Gilt yields rose for a third week last week even as BOE policy makers signaled they will keep borrowing costs low, a sign Carney may struggle to cap higher market rates that risk choking off the recovery. Benchmark 10-year yields, a guide to borrowing costs from companies to the government, are about half a percentage point higher than at the start of the year.
The International Monetary Fund this week lifted its estimate for the British economy in 2013 while simultaneously lowering its euro-area forecast, predicting contractions in France, Italy and Spain. Ten-year gilts are the cheapest versus similar-maturity German bunds in three years, a sign of growing U.K. economic confidence, after reports on services and housing suggested growth is gathering pace.
“The economic numbers in the U.K. are looking a lot better than in the euro zone and the spread is reflecting those fundamentals,” Jason Simpson, a U.K. rates strategist at Banco Santander SA in London, said on July 9. “The backdrop does look like it’s going to continue to improve in the U.K. and it will be a wrestling match between the BOE and the market, with the market biased toward pushing yields higher.”
Ten-year gilt yields decreased six basis points, or 0.06 percentage point, to 2.35 percent at 12:14 p.m. London time, leaving the yield difference to bunds at 75 basis points. The spread widened to 78 basis points on July 8, the most since June 2010.
While data last week showed services and manufacturing output accelerated in June, a government report last month showed U.K. gross domestic product shrank more than previously estimated from its peak in 2008 to the depths of the recession, a sign it may take longer for the economy to return to full capacity.
Gilts are also under pressure amid a global rout in fixed-income assets fueled by Federal Reserve Chairman Ben S. Bernanke’s outline for reducing U.S. stimulus.
The U.K. yield curve, the difference between the rates on debt of various maturities, steepened after Bernanke said June 19 the Fed may begin to slow its $85 billion in monthly bond purchases this year and end them in mid-2014 should the U.S. economy meet the central bank’s goals.
Gilts rose today after Bernanke said yesterday that the U.S. economy still requires very accommodative monetary stimulus, even as minutes of the central bank’s June meeting showed them debating whether to stop bond buying in 2013.
“I don’t think the economy can take much higher yields,” said Robin Marshall, a director of fixed-income in London at Smith & Williamson Investment Management, which oversees the equivalent of $22 billion. “There’s a danger that the recovery gets short-circuited. Carney is going to have to work hard to talk yields down and get markets to focus more on the domestic economy. It could become a thorny issue as things go forward, unless they can defuse market expectations of higher rates.”
The U.K. recovery “remains weak” by historical standards and rising market-borrowing costs pose a threat, the BOE said in a statement after its July 3-4 meeting. The pound dropped after the statement and short-sterling futures rose, indicating traders were reducing bets on higher interest rates.
Sterling slumped 2.1 percent versus the dollar last week, its biggest slide since the period ended Feb. 22. It was at $1.5104 today after falling to $1.4814 on July 9, the lowest level since June 2010.
The U.K. yield curve remains steeper than Germany’s, suggesting investors have differing outlooks for the nations. The difference in yields between U.K. two- and 30-year gilts is 319 basis points, while the equivalent measure for German securities is 231 basis points.
While 10-year U.K. rates slid after the Bank of England’s policy statement, they surged 11 basis points the following day when data showing faster-than-forecast U.S. jobs growth underscored the case for the Fed to reduce its quantitative-easing program.
The Bank of England may underline its determination to break the correlation between yields on gilts and Treasuries by increasing its asset-purchase target from 375 billion pounds, according to BNP Paribas SA. More stimulus may also foster the recovery after weaker-than-forecast industrial data on July 9 suggested a broad-based rebound is struggling to take hold.
“There’s still a long way to go on the economy, because we’ve become so accustomed to quite anemic growth,” David Tinsley, chief U.K. economist at BNP Paribas in London and a former Bank of England official, said yesterday. “The very latest data is erratically strong and I wouldn’t be surprised to see it cool off in the second half of the year.”
BNP Paribas forecasts the 10-year gilt yield will fall to 2.20 percent next month.
The U.K.-Germany yield spread will narrow to 53 basis points by the end of the year as 10-year gilt yields fall to 2.28 percent, according to economists forecasts compiled by Bloomberg. That compares with an average spread of 44 basis points over the past five years.
The IMF said on July 9 that the U.K. economy will grow 0.9 percent this year, 0.3 percentage point faster than it estimated in April. Euro-area gross domestic product will shrink 0.6 percent, the Washington-based fund predicted. The IMF projected a 0.3 percent contraction for the euro area in April.
“Expectations that Carney will do more stimulus are being taken back because the U.K. data recently has been quite strong,” Allan von Mehren, chief analyst at Danske Bank A/S (DANSKE) in Copenhagen, said yesterday. “That is putting more pressure on U.K. bonds, whereas the ECB has a weaker outlook and is managing to talk down bond yields in the euro-region.”
To contact the reporter on this story: Emma Charlton in London at email@example.com