By Nick Cawley
LONDON--The U.K. government may soon join its counterparts in Germany,
the Netherlands, Austria, Finland and Denmark in being paid by
investors for the privilege of parking their funds with it.
Yields on two-year government bonds appear likely to turn negative if
investor demand for top-quality assets continues unabated, a
development that would mean the troubles in the euro zone are also
having some positive benefits for the U.K..
The strong gains in gilts, as U.K. government bonds are known, also
reflects growing expectations that the Bank of England may lower
interest rates further.
"Short-dated gilt yields may well dip into negative territory," said
Vatsala Datta at Lloyds Bank WBM, adding that it may be difficult to
sustain these gains unless official rates were cut.
U.K. government bonds traded at record-low yields on Monday with the
short-end of the curve moving inexorably towards the 'negative zone.'
At 1340 GMT the yield on the 2.25% 2014 gilt was nearly five basis
points lower at just 0.07%, while the five-year benchmark, the 1.75%
January 2017 was nearly five basis points lower at 0.43%, according to
data from Tradeweb.
The 10-year U.K. benchmark also printed a record low yield of 1.411%,
seven basis points lower on Friday's close.
The gains in gilts come despite the continued challenges faced by the
government to bring down its budget deficit and reflect a clamour for
secure assets following the decision by the ECB to lower its deposit
rate to zero.
"With the European Central Bank recently cutting their interest rates
and the MPC minutes talking about a possible interest-rate cut, albeit
in a few months, gilts still look an attractive opportunity," noted
Sam Hill, fixed income strategist at the Royal Bank of Canada Capital
Markets.
At last Wednesday's publication of the July Monetary Policy Committee
minutes, hints were made that unless current policy initiatives proved
successful in re-invigorating the U.K. economy, an interest-rate cut
may be considered.
"The key question for the Committee was whether an additional stimulus
was required over and above these initiatives," noted the minutes,
adding "The arguments for and against a cut in Bank Rate at this
meeting were the same as before... the Committee could review this
option again when the impact of the Funding for Lending scheme and
other policy initiatives was more readily apparent; that was unlikely
to be for several months."
Adding impetus to the push lower in U.K. bond yields, a raft of
negative euro zone headlines hit the screens Monday sending investors
fleeing into haven assets. Following news of Valencia's decision to
seek a bailout, a further six Spanish regions are reported having
difficulties funding themselves and may ask for aid under the EUR18
billion Spanish government emergency loan fund.
In Greece the Troika--a commission of experts from the European Union
Commission, the European Central Bank and the International Monetary
Fund--is set to visit Greece Tuesday to assess the country's progress
on reforms and austerity measures, coming in the wake of comments from
German Economy Minister Phillip Roesler that he had "great skepticism"
about Greece and whether it would be able to fulfill its commitments
under the memorandum of understanding for the 173 billion euro ($210
billion) international aid program.
Along with increased expectations of a rate cut this year and ongoing
haven buying, a supply and demand mismatch over the next month will
apply additional downward pressure on gilt yields, especially as
pension funds and asset managers are thought to be actively buying the
market. The recently re-activated Asset Purchase Programme is
currently draining GBP3 billion of multi-maturity gilts out of the
market each week while the next sale of conventional U.K. gilts is not
scheduled until August 16.
"While the short-end of the gilt market is currently being distorted
by events in Europe, the out-performance of medium-term gilts has
certainly been aided by the supply/demand mismatch," noted Ms Datta at
Lloyds Bank WBM.
Write to Nick Cawley at nick.cawley@dowjones.com
(Franziska Scheven contributed to this article)
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(END) Dow Jones Newswires
July 23, 2012 10:55 ET (14:55 GMT)
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