UK yields hit 7-month lows

LONDON: British gilt futures climbed with Bunds and short-dated yields hit 7-month lows on Wednesday as worries about global growth and the euro zone debt crisis eroded risk appetite and knocked share prices.

Strategists said continued uncertainty over how Europe will solve Greece's debt problems had undermined bonds in the euro zone's periphery and boosted the appeal of safe haven assets.

Federal Reserve Chairman Ben Bernanke's comments late on Tuesday about the "still-fragile recovery" in the United States reinforced fears about an economic slowdown and lifted gilts, Bunds and Treasuries.September gilt futures settled 41 ticks higher at 120.44, while the equivalent German Bund future was 40 ticks up on the day.

Britain's leading shares fell by nearly 1 percent and European shares were 0.9 percent lower to close at a 3-month low as concerns about a slowdown in the global economy eroded risk appetite.

"You've got a flight to quality move where equities are falling and bonds are rising," said J.P. Morgan strategist Francis Diamond. "Gilts moved pretty much in line with Bunds, driven by weakness in equities and further underperformance by Greece on noises around a potential restructuring and what that might mean."

Gilts had fallen sharply earlier in the session after comments from rating agency Moody's stoked fears weak growth could undermine Britain's austerity measures.

A media report quoted a Moody's analyst as saying the UK could lose its top-notch rating if growth remained weak and the government failed to meet its fiscal consolidation targets.

Moody's later said the outlook for the triple-A rating remained stable but weaker growth and any slippage in the government's fiscal plans could lead to a reassessment.

Strategists said markets initially overreacted and the comments did not materially increase the chance of a downgrade, though concerns about the UK fiscal programme's reliance on healthy growth were valid. "The market is very sensitive to how the economy performs.

That is a clear risk where gilt sales and the borrowing requirement could be higher (than forecast)," said Sam Hill, fixed income strategist at Royal Bank of Canada.

Britain's government aims to largely eliminate a budget deficit of around 10 percent of GDP over the next four years, but official fiscal forecasts assume gross domestic product growth of 2.8-2.9 percent from 2013 onwards.

In the cash market, 10-year gilt yields fell by 4 basis points to 3.291 percent, leaving the spread over Bunds little changed at around 23 basis points.

Two-year gilt yields hit their lowest since mid-November at 0.836 percent before ending the session at 0.865 percent. Five-year gilts made a similar move to go as low as 1.842 percent, also a 7-month low.Thursday's focus will be on monetary policy when European

Central Bank President Jean-Claude Trichet is expected to signal a July rate rise.

Economists polled by Reuters do not expect the Bank of England to raise borrowing costs at the end of its policy meeting on Thursday. Money markets are not fully pricing in a 0.25 percent UK rise until next April nearly a year later than they were positioning for just a couple of months ago.

Copyright Reuters, 2011