Morgan Stanley Sees Post-Brexit BOE Policy Sinking U.K. Yields

  • Ten-year gilts post longest winning streak since September
  • Bonds rise, pound drops as services slow more than forecast

U.K. 10-year government bond yields may slide as much as 0.2 percentage point should Britons vote to leave the European Union in a referendum next month because investors will price in the possibility of the Bank of England maintaining record-low interest rates for longer, according to Morgan Stanley.

“Investors would expect the MPC to become more accommodative, which would support the front-end, while increased risk aversion would support 10-year and longer maturities,” Anton Heese, London-based head of European rates strategy at the company, a primary dealer in gilts, wrote in a client note on Thursday, referring to the BOE’s Monetary Policy Committee. “We do not expect substantial selling of gilts from non-domestic investors.”

The pound, the worst-performing Group-of-10 currency this year, has taken the brunt of investors’ concern before a June 23 vote that may lead to Britain leaving the world’s largest trading bloc. Gilts have largely avoided the turmoil, outperforming Treasuries and German securities this year, according to Bloomberg World Bond Indexes, as the prospect of a slowing economy and a prolonged period of low interest rates boosted demand for the securities.

Winning Streak

Ten-year gilts advanced for a sixth day on Thursday, the longest stretch of gains since September, as a report showed a gauge of services fell last month to its lowest level in more than three years, coming after bigger-than-expected declines in manufacturing and construction indexes earlier in the week.

Benchmark 10-year gilt yields fell five basis points, or 0.05 percentage point, to 1.48 percent as of 4:11 p.m. London time, the lowest level since April 20. The 2 percent bond due in September 2025 rose 0.45, or 4.500 pounds per 1,000-pound ($1,449) face amount, to 104.56. The yield dropped 13 basis points in the previous five days. U.K. financial markets were closed May 2 for a holiday.

“We estimate the initial response would be for 10-year gilts to rally 10 to 20 basis points, which may seem aggressive given the starting point for gilt valuations,” Heese wrote. “However, we would point out that gilts are trading roughly in line with other G-4 rates markets, so we do not see anything priced in for Brexit at present.”

The pound was little changed at $1.4492 after falling earlier to $1.4444, the lowest since April 25. Sterling strengthened for the first time in five days versus the euro, gaining 0.8 percent to 78.65 pence, having touched 79.47 pence Wednesday, the weakest level since April 18.

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