Pimco Sees Gilt Risk From Carney’s Muddied Guidance: U.K. Credit

Bank of England Governor Mark Carney’s overhaul of his forward-guidance policy is penalizing U.K. government bonds relative to their U.S. and European peers.

By abandoning its unemployment threshold for reviewing interest rates, the BOE has made gilts less attractive than the debt of developed nations where the path of policy is perceived to be clearer, according to Pacific Investment Management Co. Gilts gained 0.4 percent between Feb. 11, the day before officials outlined their new policy focus, and the end of last week, underperforming U.S. and euro-area securities, Bloomberg World Bond Indexes show.

“For a central bank that clearly shows more willingness to shift its rhetoric, you should expect a higher risk premia in that bond market, relative to other markets, where the rhetoric doesn’t shift,” Mike Amey, a London-based money manager at Pimco, which manages the world’s biggest bond fund, said in an interview.

As the Monetary Policy Committee prepares to meet this week, Carney is struggling to restrain expectations that Britain will be the first Group of Seven nation to raise borrowing costs.

The BOE was forced to refine forward guidance after the strongest growth since 2007 sent the jobless rate tumbling toward the 7 percent threshold for considering a rate increase. The policy is now focused on a broader range of indicators, with officials pledging not to raise the benchmark interest rate from 0.5 percent until more spare capacity is used up. The implied yield on short sterling contracts expiring in December is 0.75 percent.

MPC Differences

BOE Chief Economist Spencer Dale said last month market bets on a rate increase in the spring of next year are reasonable, and his colleague Martin Weale said an earlier move might be needed if wages pick up more than predicted. David Miles, another MPC member, acknowledged differences on the nine-member panel when he said in a Bloomberg interview there is a “range of views” about how much slack is in the economy.

European Central Bank President Mario Draghi has stuck to the message that officials are ready to add stimulus if deflation risks increase, suppressing bond yields from Germany to Portugal. Federal Reserve Chair Janet Yellen, like her predecessor Ben. S. Bernanke, has reassured investors that reducing bond buying won’t automatically lead to higher interest rates.

Yield Spreads

The extra yield that investors demand for holding five-year gilts instead of equivalent German debt rose to 104 basis points on Feb. 13, the most since September 2007. The spread over Treasury notes reached 19 basis points on the same day, having yielded 22 basis points less in August.

“Gradually investors should be building more term premium into gilts,” said Henry Skeoch, a strategist at Barclays Plc in London, who predicts U.K. debt will underperform German bonds. “The first iteration of forward-rate guidance had a clear anchor and we hit that pretty quickly. Now you have this notion of spare capacity, which is very hard to observe.”

The MPC will leave its benchmark interest rate on hold after their monthly meeting March 5-6, according to all 52 economists in Bloomberg survey. This month marks the fifth anniversary of rates being at a record low.

ECB Options

The bonds of the 18 nations that share the euro are rising amid speculation that inflation at less than half the ECB’s target will prompt officials, who also meet on March 6, to add to their stimulus. Policy makers are “ready to take any action” should deflation risks increase, Draghi said after a Group of 20 meeting in Sydney on Feb. 23.

ECB options include cutting the refinancing rate from a record-low 0.25 percent, ending the mopping-up of excess liquidity from the since-terminated Securities Markets Program or printing money in a program known as quantitative easing. In December, the Fed began slowing its asset-purchase program, now at a pace of $65 billion per month. The Federal Open Market Committee next meets March 18-19.

“The real distinction here is between European bonds, and U.K. and U.S. bonds,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which has about $20 billion. “The commitment that rates will stay low for a long time is slowly fading away. This is true of the U.K. and the Fed but not for the ECB.”

He recommends investors should sell gilts and Treasuries, while buying debt from the euro-region.

Yield Forecasts

Ten-year gilt yields will increase to 3.4 percent by the end of this year, according to the median estimate in a Bloomberg survey of forecasts, the same as forecasts for similar-maturity U.S. yields. German bund yields will end the year at 2.3 percent, a separate survey shows.

Investors buying 10-year gilts today would lose 4 percent including reinvested interest, should the yield end 2014 at 3.4 percent, according to data compiled by Bloomberg. An investment in similar-maturity Treasuries would lose 4.5 percent. Bunds would hand investors a loss of 5.4 percent if the yield climbs to 2.3 percent.

The 10-year gilt yielded 2.70 percent today, the rate on similar-maturity German debt was 1.60 percent and Treasuries 2.66 percent.

“The MPC have a pretty wide range of personal views, and that can lead to confusion in the market,” said David Schnautz, a fixed-income strategist at Commerzbank AG in New York. “The BOE has the first mover disadvantage because they are already more advanced in heading for the exit door. When you are in the set framework the path was clear. Now, it’s a very uncertain environment.”

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