U.K. Bonds Underperform Bunds as Polls Putting Economy in Shade

U.K. government bonds fell, trailing behind their German peers, as investors cooled to the debt of a nation heading into an election too close to call and that potentially will alter how the country manages its finances.

With no significant U.K. economic data released on Wednesday, investor focus remained on the May 7 vote that opinion polls signal will produce a hung parliament. German bunds rallied as European Central Bank President Mario Draghi said policy makers’ debt-buying plan must be implemented in full to work.

“Overseas investors have been selling gilts recently and may remain cautious ahead of the election due to the uncertain fiscal outlook,” said Nick Stamenkovic, a fixed-income strategist at broker RIA Capital Markets Ltd. in Edinburgh. “We expect gilts to lag behind bunds near-term.”

Benchmark 10-year yields increased five basis points, or 0.05 percentage point, to 1.56 percent at 4:13 p.m. London time, having touched 1.50 percent on Tuesday, the lowest since March 26. The 5 percent gilt due in March 2025 fell 0.515, or 5.15 pounds per 1,000-pound ($1,477) face amount, to 131.40.

German 10-year yields fell three basis points to 0.11 percent and reached a record-low 0.105 percent Wednesday, as Draghi signaled he will stay the course with the ECB’s bond-buying program. Gilts returned 3 percent this year through Tuesday, compared with an average 4.3 percent for the euro area, according to Bloomberg World Bond Indexes.

In the U.K., the two main parties have sparred over how to tackle a budget deficit of 5 percent of economic output, five years after the Conservatives took office and pledged to eliminate it during the life of that parliament.

Volatility Level

Concern that the election will erode budgetary leadership has also been reflected in currency markets. A gauge of anticipated price swings in the pound against the dollar in a month’s time climbed to the highest in almost five years last week.

While it has dropped in three of the past four days, to 11.66 percent Wednesday, the measure remains more than 3 percentage points higher than the average of the past five years. It climbed to as much as 13.64 percent on April 9, the highest since June 2010, according to data compiled by Bloomberg.

The pound fell 0.1 percent to $1.4768 and appreciated 0.5 percent to 71.72 pence per euro, which is being weighed by the ECB’s commitment to a quantitative-easing program that typically debases currencies.

Ten-year gilt yields reversed more than half of the eight-basis-point drop from Tuesday, when the Office for National Statistics in London said the inflation rate remained at zero for a second month in March. That supported gilts, as it means there is less pressure on the Bank of England to raise its key interest rate from a record-low 0.5 percent.

The five-year break-even rate, a measure of the outlook for inflation derived from the yield difference between gilts and index-linked securities, was two basis points higher at 2.46 percentage points, having reached 2.51 percentage points on Monday, the most since Jan. 2.

Before it's here, it's on the Bloomberg Terminal.