Global growth fears drive gilt yields to new record low

LONDON: British government bond yields hit all-time lows for the third consecutive day on Wednesday as worries grew that a weakening global economy would aggravate Europe's debt crisis.

Yields on Italian government bonds have surged to 14-year highs while European shares closed at an 11-month low as a sense of crisis dominated thin, summer trading.

Britain's position outside the euro zone and the government's commitment to fiscal austerity have conferred on gilts a safe-haven status, helping them outperform Bunds in recent months. Norwegian and Swedish government bond prices have also jumped.

Ten-year gilts fell as low as 2.707 percent -- a new record low, and a drop of more than a percentage point since April -- and finished the day 2 basis points down at 2.74 percent.

"In an extreme situation, my feeling is that gilt yields could even go lower," said Russell Silberston, head of interest rate strategy at Investec Asset Management. "There's so much money fleeing peripheral Europe. When capital preservation is key, investors are almost insensitive to yield."

The September gilt future was settled 26 ticks higher at 126.29, outperforming the equivalent Bund future by 25 ticks, and rowing back after two days of underperformance.

The future hit a new contract high of 126.72 as markets digested weak US industrial orders and services PMI data released at 1400 GMT .

Ultra-long gilts led the price gains, with strategists saying they offered the best value to yield-starved investors after several months of underperformance relative to the belly of the curve.

Thirty-year gilt yields fell 6 basis points on the day to 1.31 percent, and briefly touched their lowest level since October last year at 1.268 percent.

Leading British shares closed more than 2 percent lower as concerns grew about a global slowdown in services activity -- to which Britain proved a rare exception.

Britain's services sector grew at its fastest pace in the four months in July, but price pressures weakened, supporting the view that the Bank of England could loosen policy further if the storm clouds over the global economy failed to lift.

Lloyds strategist Eric Wand said that at the margins, the stronger services PMI could be behind some of the outperformance of gilts versus bunds and longer-dated gilts versus shorter gilts, as it reduced risks to the British government's fiscal consolidation plans.

But he also said that spreads in both cases had looked too wide even before Wednesday's data, offering scope for outperformance from a technical point of view.

BoE policymakers conclude their two-day monthly meeting at midday on Thursday. Most economists expect no change to policy, but there is an outside chance they will signal a second wave of quantitative easing.

Reports earlier this week showed US manufacturing growth came to a virtual standstill while consumer spending fell for the first time in two years.

Such concerns have also revived worries about the euro zone's heavily indebted peripheral states, which are relying on externally generated demand to offset severe austerity measures at home to help them reduce their debt burden.

Copyright Reuters, 2011