British Bonds Beat Treasuries as Scots Vote Sparks BOE Caution

Scotland’s referendum on independence is providing a fillip to investors in U.K. government bonds as they add to bets borrowing costs will stay lower for longer.

Britain’s 10-year gilt yields have fallen to the lowest in more than a year relative to their U.S. counterparts. Far from deserting the market, investors supported gilts on speculation the Bank of England may need to adjust its policy path in the face of potential market turbulence.

With surveys showing the Sept. 18 referendum on a knife edge, gilts have been shielded from a selloff in Treasuries amid bets that Federal Reserve officials will signal this week they are moving closer to raising interest rates for the first time since 2006.

“Clearly the Scottish vote is a factor because there is broad-based consensus that if the ‘yes’ wins, the economic impact would be negative and would probably delay the first hike from the Bank of England,” said Vincent Chaigneau, global head of rates and foreign-exchange strategy at Societe Generale SA in Paris. “Against that the U.S. data has been solid and you’ve seen, not just ahead of the Scottish vote, quite a big move in the short-term interest-rate differential.”

Yield Discount

At about 2.54 percent, U.K. 10-year yields were 4.7 basis points below those on similar-maturity Treasuries at 4:25 p.m. London time. The yield discount reached 8.2 basis points at the end of last week, the most since August 2013, based on Bloomberg generic data. Three months ago, the U.K. securities yielded 16 basis points more than the U.S. securities.

While two-year gilts still yield more than Treasuries, the spread has narrowed to 28 basis points from a 2014 high of 45 basis points in July.

Gilts have outperformed their U.S. peers in the past week even after BOE Governor Mark Carney signaled on Sept. 9 that officials will probably increase their benchmark rate from a record-low 0.5 percent in spring next year as the recovery gains momentum. With the U.K. economy on track to outperform its Group-of-Seven peers this year, investors had been bracing for higher interest rates.

That changed after a YouGov survey published on Sept. 7 showed Scottish nationalists seeking to break away from the U.K.’s 307 year-old union were in the lead. This weekend at least four more polls were released, three of which showed the “no” campaign against independence was ahead. The fourth, a survey by ICM Research for the Sunday Telegraph, put “yes” ahead by eight percentage points excluding undecided voters.

Rates Bets

Investors have pushed out bets on the timing of the first U.K. rate increase, with futures contracts showing the key rate will increase 25 basis points by May, versus bets at the beginning of last month for a move by February.

The pound fell for the first time in five days against the dollar, with a report tomorrow forecast by economists in a Bloomberg survey to show the annual inflation rate slowed to 1.5 percent in August, supporting the case for the BOE to keep rates on hold. Separate reports in the U.S. today showed manufacturing in New York state expanded in September and unexpectedly declined nationwide in August.

Sterling slipped 0.2 percent to $1.6234, having gained 1 percent in the previous four days. It was little changed versus the euro at 79.75 pence.

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