U.K. Inflation-Linked Gilts Rally on Bets Carney May Ease

U.K. inflation expectations rose to the highest level in 21 months amid speculation Mark Carney will expand monetary policy and spur price rises when he takes over as Bank of England governor in July.

The so-called break-even rate increased for a fifth day before Carney testifies to U.K. lawmakers this week after telling the World Economic Forum’s annual meeting in Davos, Switzerland, last month that policy in developed countries isn’t “maxed out.” Ten-year bonds fell after an industry report showed U.K. services expanded in January, undermining demand for fixed-income assets. The pound weakened against the euro.

“In the last week or so the outperformance of inflation-linked gilts has accelerated and that’s partly to do with Carney,” said Jamie Searle, a fixed-income strategist at Citigroup Inc. in London. “People are expecting him to be quite dovish. His appearance in front of the Treasury Select Committee will be important for providing clues. It’s understandable that break-evens have rallied but more from here will be difficult.”

The 10-year break-even rate, derived from the yield difference between gilts and inflation-linked securities, added one basis point, or 0.01 percentage point, to 3.24 percentage points at 4:32 p.m. in London after reaching 3.27 percentage points, the most since April 14, 2011.

Carney, currently Governor of the Bank of Canada, will testify before U.K. lawmakers in London on Feb. 7, five months before he succeeds Mervyn King. Under King, the central bank cut its benchmark interest rate to a record-low 0.5 percent and started a bond-buying facility that had purchased 375 billion pounds ($587 billion) of assets by November.

Linker Sale

The U.K. sold 1.1 billion pounds of inflation-linked bonds due in March 2024 today at a record-low real yield of minus 0.844 percent, compared with minus 0.583 percent at the previous auction on Dec. 13. Investors submitted bids for 1.97 times the amount allotted, versus 2.37 times in December.

The securities allow retirement savings to keep pace with inflation because the principal and coupon payments are adjusted for rising prices.

U.K. inflation-linked gilts have returned 4.1 percent this year through yesterday, according to indexes compiled by Bank of America Merrill Lynch. That compares with a loss of 1.8 percent for government bonds not linked to inflation.

Ten-year gilt yields climbed toward the highest level since April as the growth in U.K. services eased speculation the economy is headed for a triple-dip recession.

The yield rose five basis points, or 0.05 percentage point, to 2.12 percent after increasing to 2.17 percent yesterday, the most since April 20. The 1.75 percent bond maturing in September 2022 dropped 0.385, or 3.85 pounds per 1,000-pound face amount, to 96.78.

Pound Drops

The pound weakened 1.2 percent to 86.75 pence per euro after strengthening as much as 0.2 percent following the release of the services data. The U.K. currency dropped 0.6 to $1.564, after falling to $1.5647, the least since Aug. 16.

Sterling has depreciated 4.2 percent this year, the second-worst performer after the yen among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro rose 3.2 percent and the dollar dropped 0.2 percent.

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