Gilts rose for a third week, sending ten-year yields to record lows, as volatile markets boosted demand for safer assets and the Bank of England's inflation report indicated prices will moderate as the economy falters.
The difference in yield between two- and ten-year government securities narrowed to 186 basis points, the least since March 2009, as investors added to bets that slowing growth and inflation will keep interest rates near zero. Stock markets fluctuated between gains and losses in the wake of Standard & Poor's downgrade of the US and concern that French banks were having trouble funding themselves.
"Despite ten-year gilt yields reaching a new low, we believe yields can move lower," said Anthony O'Brien, a fixed-income strategist at Morgan Stanley in London. "The inflation report suggests that the bank rate will remain low for a long period. Financial markets are going to continue to be very volatile over the next few weeks, and in that environment, safe AAA assets like gilts continue to be a good investment."
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Yields on ten-year gilts declined 16 basis points in the week to 2.53 per cent on Friday, up from 2.459 per cent on August 11, the lowest since Bloomberg began collecting the data in January 1989. Yields on two-year notes rose ten basis points in the week to 0.65 per cent.
Sterling fell 0.7 per cent against the dollar last week to $1.6280 (Dh5.9798). The pound declined 0.3 per cent versus the euro. Near-term growth in the UK is "likely to remain sluggish" and inflation should be "a little below target in the medium term," the central bank said on August 10.
Governor Mervyn King said inflation may undershoot the central bank's 2 per cent target and the UK has "flexibility" to adjust policies if growth proves to be weaker than expected.
"The Bank of England has moved closer to engaging in a further round of quantitative easing," BNP Paribas said. "We have therefore changed our forecast and now expect that the Bank will engage in a further round of quantitative easing of up to £100 billion (Dh598 billion) of gilt purchases."
The implied yield on short-sterling futures expiring in June 2013 has plunged 171 basis points, or 1.71 percentage points, this year as traders raised bets that benchmark rates will remain lower for longer.
UK gilts have handed investors a 7.1 per cent return this year, compared with 6.4 per cent for US Treasuries.