Medium-term UK gilts outlook remains rosy

Louisa Bojesen
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IN WHAT was one of the most important Fed meetings of recent times last week, the US central bank moved to support lower borrowing costs by reinvesting funds from maturing mortgage-backed securities in longer term government bonds. While this had been touted as a potential option for the Fed, most thought it would save some fire power for later in the year and merely downgrade its economic assessments.

Fourteen hours later, I attended the press conference for the Bank’s Inflation Report, where policymakers echoed the US on worries over the strength of the economic recovery. The Bank cut its growth forecast to just over three per cent in two years’ time (down from 3.6 per cent) and said inflation would remain above target until the end of 2011. It also left the door open for further policy easing if the economy weakens considerably from here.

I asked Mervyn King, the Bank’s governor, if he was worried that the stimulus measures weren’t translating into sustainable growth and jobs. He answered that that would be to exaggerate concerns, adding: “Clearly we have to look carefully at what is happening in the short term too, and if it is necessary to respond, then we are quite ready to do that. But the experience of all financial crises suggests that a typical recovery is relatively slow and sluggish. And it takes a long time to use up the spare capacity that has been created. What we have seen so far in terms of the actual data has been bang in line with the average of these financial crises in the past. So I think it is much too soon to say that we are struggling to see a recovery.”

Nevertheless, equity markets were spooked by the central bank activity. In the bond markets, the yield on the US two-year Treasury note hit a record low, and the yield on the benchmark 10-year note in both the US and Germany hit multi-month lows as well.

So with people seeking cover in lower-risk government debt, what is the outlook for UK gilts? Sam Hill, a fixed income strategist at RBC Capital Markets, told me that in the short term, the gilt market looks vulnerable to a setback, but the medium term should still present some good opportunities. Hill pointed out that after the latest gilt auction, the debt management office has now raised half the money it needs so far, which means it has covered half of the UK deficit in the first third of this year. From a supply point of view, according to Hill, the outlook for the gilt market is still positive for the rest of the year.

Louisa Bojesen is an anchor on CNBC