Bloomberg News

U.K. Inflation Bonds Surge on Index as Pound Falls Versus Euro

January 10, 2013

U.K. inflation-linked bonds advanced, pushing 10-year yields to an all-time low, after the Office for National Statistics said it will maintain its current formula for calculating the retail price index.

The pound fell against the euro as the Bank of England kept its benchmark interest rate at a record-low 0.5 percent and its asset-purchase target at 375 billion pounds ($602 billion). The European Central Bank also left interest rates unchanged. Ten- year yields on the inflation-protected securities rose to a six- month high last week on concern the ONS would change the index’s calculation, potentially denting returns. Ten-year gilts fell for the first time in four days.

“There’s no breach of contract from a legal or financial perspective and that is good for confidence in Great Britain as a place to do business,” Andrew Bosomworth, managing director at Pacific Investment Management Co. in Munich, said about the statistics office’s decision in an interview on Bloomberg Television’s “The Pulse” with Francine Lacqua and Guy Johnson. “A change of the contract could have consequences, obviously, as today’s price action suggests.”

The U.K. 10-year inflation-linked yield tumbled to a record-low minus 0.99 percent. The rate was 34 basis points, or 0.34 percentage point, lower at minus 0.97 percent at 4:40 p.m. London time. A negative yield means investors buying the securities will receive payments below the retail price index if they are held to maturity.

The 10-year gilt yield climbed seven basis points to 2.09 percent, after falling 10 basis points over the previous three days. The 1.75 percent bond due in September 2022 dropped 0.59, or 5.90 pounds per 1,000-pound face amount, to 97.01.

Central Bank

Sterling weakened 0.6 percent to 82 pence per euro, after depreciating to 82.07 pence, the weakest level since Dec. 28. The pound gained 0.6 percent to $1.6116 after the Bank of England’s interest-rate decision. It fell to $1.5993 yesterday, the lowest level since Nov. 30.

“Inaction was widely expected” from the Bank of England, said Daragh Maher, a currency strategist at HSBC Holdings Plc in London. “The mood on the currency has been a bit heavy of late and I suspect the market will shrug its shoulders and test for a little more pound weakness.”

The ECB kept its main refinancing rate at a record-low 0.75 percent, as forecast by 50 of 55 economists surveyed by Bloomberg News. Five had predicted a cut to 0.5 percent.

Unanimous Decision

The euro-area economy should gradually recover and the decision to refrain from cutting rates was unanimous, ECB President Mario Draghi said at a news conference in Frankfurt afterwards.

“Draghi is presenting a more hawkish tone than the market was anticipating,” said Neil Jones, head of European hedge fund sales at Mizuho Corporate Bank Ltd. in London. “The fact that the euro is outperforming the pound tells me this is blanket- coverage euro buying.”

The U.K. currency has fallen 0.6 percent in the past week, the third-worst performer among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. The yen dropped 1.9 percent and the dollar lost 0.7 percent.

U.K. inflation-linked bonds, which pay investors based on changes in the retail-price index, had underperformed gilts this month before today’s ONS decision amid concern adjustments to the retail-price gauge would reduce returns.

Index-linked securities handed investors a 3 percent loss this year through yesterday, after making a 0.8 percent return in 2012, according to indexes compiled by Bank of America Merrill Lynch. Conventional gilts lost 1.4 percent in 2013. They returned 2.8 percent last year.

Removes Uncertainty

“Index-linked gilts should rally on the back of this” decision from the statistics office, said Elisabeth Afseth, a fixed-income analyst at Investec Bank Plc in London. “It’s good in that it takes away all the uncertainty but it’s also a recognition that they aren’t fiddling with the index for the sake of lowering it, so on a reputational side for the U.K. that’s also good.”

The U.K. 10-year break-even rate, the difference in yield between conventional gilts and inflation-protected securities, had its biggest intraday gain since Bloomberg began collecting the data in 1992, widening as much as 40 basis points to 306 basis points.

The statistics office will develop a new inflation index known as RPIJ to adjust the measurement of clothing prices in the RPI, it said in London.

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net


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