U.K. Bond Investors Favor Two-Year Debt as BOE Rate Bets Trimmed

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For the first time in five weeks, U.K. shorter-dated government securities beat those due in a decade as investors bet on record-low interest rates for longer.

With money-market derivatives showing traders aren’t expecting a rate increase from the Bank of England in the next year, the pound fell for a second week against the euro. A report Aug. 18 will show U.K. inflation was stagnant in July, according to a Bloomberg survey of economists, putting no pressure on policy makers to raise borrowing costs anytime soon. Risks of global deflation were highlighted after China unexpectedly devalued the yuan, days after data showed a slump in exports from the world’s second-largest economy.

“There is nothing that’s going to happen to U.K. rates until 2016” and possibly even later, Stephen Jones, chief investment officer at Edinburgh-based Kames Capital, which oversees about $90 billion, said in an interview this week. “There is no pressure, certainly in the near term -- even expressed in the two-year forecast point -- that inflation is going to be anything other than acceptable.”

The extra yield, or spread, that investors get for holding 10-year gilts instead of those maturing in two years, increased four basis points, or 0.04 percentage point, this week to 130 basis points as of 4:36 p.m. London time.

BOE Timing

Two-year gilt yields rose two basis points to 0.58 percent on Friday, leaving the price of the 1.75 percent security due January 2017 at 101.665 percent of face value. In the week, the yield fell one basis point, while that on benchmark 10-year gilts climbed three basis points to 1.88 percent.

Forward contracts based on the sterling overnight index average, or Sonia, signal a 25 basis-point increase next August, compared with May as recently as Aug. 11. The BOE hasn’t raised its key rate since 2007 and the benchmark has been at 0.5 percent since 2009.

Construction output rose 0.9 percent in June from the previous month when it contracted, a government report showed Friday. That’s below the median forecast of 2 percent in a Bloomberg survey of analysts.

The pound strengthened 0.4 percent to 71.16 pence per euro on Friday, paring its decline this week to 0.6 percent. Sterling was little changed at $1.5617, up 0.8 percent since Aug. 7.

The U.K. currency is still 6.1 percent higher over the past six months, the best performer among 10 developed-market currencies, according to Bloomberg Correlation-Weighted Indexes.