Gilts Post Biggest Weekly Gain Since 1992 on BOE Rate-Cut Bets

By Gavin Finch

Dec. 20 (Bloomberg) -- U.K. 10-year government bonds posted their biggest weekly advance since October 1992 on speculation the deepening recession will force the Bank of England to cut its benchmark rate to near zero.

The gains pushed two- and 10-year yields to record lows and the pound plunged to the weakest ever against the euro as reports showed an unprecedented U.K. budget deficit last month, jobless claims rose at the fastest pace since 1991 and house prices extended declines. The Bank of Japan and the Federal Reserve cut their main interest rates to near zero this past week.

“Investors are increasingly betting the BOE will follow the Fed in cutting rates to zero and that’s driving the rally in shorter-dated gilts,” said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets, a securities broker for banks, wealth managers and institutional investors. “The data is also uniformly gloomy and points toward a worsening recession. The downward trend in yields remains intact.”

The yield on the two-year gilt slid 46 basis points in the week to 1.27 percent by 3 p.m. in London. It slipped to 1.23 percent on Dec. 18, the lowest level since at least January 1992, when Bloomberg began collating the data. The price of the 4.75 percent security due June 2010 gained 0.58, or 5.8 pounds per 1,000-pound ($1,496) face amount, to 105.01.

The yield on the 10-year security dropped 44 basis points this week to 3.16 percent, its biggest five-day decline in 16 years. Bond yields move inversely to prices.

Stamenkovic favors longer-dated gilts, predicting the yield on the 10-year security will fall to 3 percent in coming weeks.

Rate Futures

Interest-rate futures showed traders raised bets policy makers will reduce borrowing costs, with the implied yield on the March short-sterling three-month contract slipping 25 basis points in the week to 1.93 percent yesterday.

The Bank of England reduced the base rate to 2 percent on Dec. 4, down from 5.5 percent at the start of the year. The European Central Bank pared its benchmark to 2.50 percent on the same day.

Policy makers in Japan lowered the benchmark rate to 0.1 percent today after the Fed cut interest rates on Dec. 16 to a range of zero to 0.25 percent, and said it “will employ all available tools” and keep borrowing costs low for “some time.”

The pound slipped for a third week against the euro, after dropping to 95.57 pence on Dec. 18, the weakest since the common currency’s debut in 1999. It was at 93.34 pence yesterday, from 89.48 pence a week ago. It was also at $1.4910, from $1.4944.

With Britain’s economy in recession for the first time in 17 years and institutions reluctant to lend because of the global financial crisis, the Bank of England pared its benchmark rate to the lowest level in more than five decades.

ECB President Jean-Claude Trichet said there is a limit to how far the bank can cut rates and signaled it may pause in January, according to comments published on Dec. 16.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net