King to End Bond Purchases as Economy Revives, Gilt Dealers Say

By Anchalee Worrachate and Anna Rascouet

Aug. 5 (Bloomberg) -- The Bank of England will end a five- month program of bond purchases as Europe’s second-largest economy shows signs of emerging from a recession, said a majority of the firms that bid at government debt auctions.

Eight of 12 primary dealers surveyed by Bloomberg said the central bank will stop the program after announcing a pause at its monthly meeting tomorrow. Four -- BNP Paribas SA, RBC Capital Markets, Merrill Lynch & Co. and UBS AG -- predict policy makers will increase purchases.

The Bank of England has spent 125 billion pounds ($212 billion) of the 150 billion pounds authorized by the Treasury in March, equivalent to almost 10 percent of Britain’s gross domestic product, to help contain borrowing costs and pull the economy out of the recession. Central bank Governor Mervyn King’s policy of so-called quantitative easing helped spur a 23 percent increase in loans to small companies, British Bankers’ Association data show.

“The Bank of England may have done enough,” said Jamie Searle, a fixed-income strategist in London at Citigroup Inc. “They will probably announce a pause and reassure the market they can step in and resume the program quickly if need be. Our view is they won’t need to because the economy is beginning to recover.”

‘Watching’ Stance

The bank’s nine-member Monetary Policy Committee, which cut rates to a record low of 0.5 percent on March 5, voted against expanding the program on July 9 while it assessed whether the worst of the recession was over. The central bank may shift to a “watching” stance at their meeting tomorrow if officials decide the purchases worked, Andrew Sentance, a member of the committee, said in an interview in London on July 23.

Nationwide Building Society said in a July 30 report that British house prices rose for a third month in July amid a shortage of properties. The Chartered Institute of Purchasing and Supply and Markit said on Aug. 3 that manufacturing expanded last month for the first time in more than a year. The Bank of England said on July 29 mortgage approvals jumped to a 14-month high in June.

The U.K. inflation rate will be the fastest in the G-7 next year, the Paris-based Organization for Economic Cooperation and Development predicts.

“The bank is likely to pause given the upturn in leading indicators that suggests we’re through the trough,” said Francis Diamond, a fixed-income strategist in London at JPMorgan Chase & Co. “Policy makers might be cautious about continuing to provide further stimulus in this kind of environment. It’s not clear exactly what quantitative easing has done in terms of sparking growth for credit.”

Yield Increase

The 10-year gilt yield will rise to 3.95 percent by year- end after the central bank stops buying as record government debt issuance overwhelms investor demand, according to the median forecast of the 12 primary dealers. The yield on the benchmark 10-year note was at 3.85 percent in London yesterday.

The Treasury is selling 220 billion pounds of bonds in the year ending March 2010, 50 percent more than fiscal 2009.

Policy makers will expand the program because the economy will prove too weak, according to BNP Paribas. The median estimate of 25 economists surveyed by Bloomberg is for gross domestic product to contract 4.1 percent this year, followed by an expansion of 0.85 percent in 2010. Growth averaged 2.35 percent from 2001 through 2008.

“The extension of the quantitative-easing program is unavoidable, and we are bearish on gilts in the near term,” said Matteo Regesta, an interest-rate strategist at BNP Paribas in London. “Although we’ve seen some tentative signs of a gradual recovery, the economy is still quite weak.”

‘Not Necessarily Bad’

HSBC Holdings Plc predicted the biggest decline for the 10- year yield, forecasting 3.40 percent by year-end.

“The end of quantitative easing is not necessarily bad for gilts,” said Andre de Silva, deputy global head of fixed-income strategy in London at HSBC. “The currency will recover and that will enhance demand for gilts from foreign investors.”

International investors bought a net 3.3 billion pounds of gilts in June, the most since the asset-buying program began, the Bank of England said on July 29.

Scottish Widows Investment Partnership and Schroder Investment Management, two of Britain’s biggest gilt funds, said they will buy U.K. government bonds with maturities of seven years or less irrespective of the Bank of England’s decision.

Policy makers will keep the main interest rate at a record low in coming months and shorter-dated securities will benefit, said David Scammell, a money manager in London at Schroder, one of the 10 biggest holders of gilts.

Short-End ‘Comfort’

“I will still find comfort in the short end of the market,” even if the Bank of England suspends the plan, said Scammell. “There’s no sign policy makers will raise interest rates any time soon. The fact is the economy is still very, very weak.”

Scottish Widows said it moved as much as 400 million pounds from long-dated bonds into shorter maturities, betting on an end to quantitative easing, according to Rod Davidson, who is in charge of the company’s bond and foreign-exchange investments.

“All the signals are there that the program is going to end,” Davidson, who oversees 47 billion pounds of investments, said in an interview on July 28.

The 12 primary dealers that participated in the survey are Barclays Capital, BNP Paribas, Citigroup, Deutsche Bank AG, HSBC, JPMorgan, Merrill Lynch, Morgan Stanley, Nomura International Plc, RBC, Royal Bank of Scotland Group Plc and UBS. Goldman Sachs Group Inc., Credit Suisse AG and Winterflood Securities didn’t participate.

To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net; Anna Rascouet in London at arascouet@bloomberg.net