U.K. Bond Investors Seen Enduring Another Mediocre Year in 2016

  • Gilts returned 0.2% in 2015, after earning almost 15% in 2014
  • BOE seen on hold until end of 2016 as economic growth slows

U.K. government bonds eked out a positive return in 2015 and investors shouldn’t expect much more from 2016.

Global sovereign-debt markets were dominated last year by the European Central Bank’s unprecedented bond-purchase program and the Federal Reserve’s decision to raise U.S. interest rates for the first time in almost a decade. In 2016, the possibility of a referendum on Britain’s European Union membership will capture investors’ attention, though the uncertainty around the vote may be a risk to U.K. assets.

Benchmark 10-year gilt yields climbed from a record low set in January 2015. The Bank of England held interest rates at an all-time low throughout the year despite signals at times that an increase was approaching sooner than the market was pricing. With U.K. economic growth slowing, markets haven’t fully priced a move by the BOE until the end of 2016.

“Gilts have been a bit of a sideshow,” said Azim Meghji, the London-based head of U.K. fixed income at Santander Asset Management, which manages the equivalent of $170 billion. “The focus for most investors has been what the ECB are going to do and what the Fed will do and those have been two competing themes throughout 2015, which has left gilts at the mercy of where the broad market for government bonds has gone.”

The benchmark 10-year gilt yielded 1.96 percent as of 1 p.m. close on Dec. 31 in London. The yield dropped to a record-low 1.325 percent on Jan. 30, and peaked at 2.21 percent in June.

With U.K. inflation near zero and the outlook for global growth remaining shaky, BOE officials have less incentive to raise interest rates. Recent data showed wage growth, a key focus of deciding monetary policy, had slowed and so policy makers can remain cautious for the time being, Santander’s Meghji said.

Forward contracts based on the sterling overnight index average, or Sonia, aren’t fully pricing in a 25-basis-point increase to U.K. interest rates until November 2016.

Returns Slide

Gilts returned 0.2 percent in 2015 through Dec. 30, according to Bloomberg World Bond Indexes. In 2014, they earned almost 15 percent. Euro-area sovereign securities earned 1.70 percent in the same period, versus 13 percent in 2014.

“After 2014 being a blockbuster year, 2015 being a mediocre year, I wouldn’t expect 2016 to be significantly different at this stage than the year we just had,” Meghji said.

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