Negative-Rate Debate Is Powering Gilts’ Longest Rally in Decade

LONDON (Capital Markets in Africa) — The longest U.K. bond rally in a decade has seen yields close in on German equivalents, fueled by the prospect that the Bank of England could cut interest rates below zero next year.

Yield premiums on 10-year gilts over bunds have hit lows unseen since 2016, as bets increase that the BOE will add monetary stimulus to support an economy struggling with the impact of the coronavirus pandemic. U.K. bonds are on track for a fifth monthly advance, the longest winning streak since 2010, after the central bank slashed rates and boosted its asset-purchase program in March.

BOE officials have refrained from ruling out negative rates in recent weeks, leading money markets to price in the prospect for August 2021. The gilt-bund yield spread narrowed by four basis points Tuesday to 63, taking the drop in 2020 to 37 basis points, as German bonds declined ahead of an auction of similarly-rated Dutch debt. U.K. bond yields have already turned negative up to the maturity of five years.

The prospect of negative rates “is in the price already” in the gilt market, according to Peter Chatwell, head of the multi-asset strategy at Mizuho International Plc. “The drivers from here would be more about supply versus BOE quantitative easing. As this pushes more of the gilt curve below 0%, it forces some investors (if they cannot buy negative-yielding bonds) to go longer on the curve to maintain their exposure.”

Ten-year yields in Germany have been negative for a year now. The European Central Bank has held sub-zero rates since 2014, a major factor behind driving most of the bund curve below zero. Unlike the BOE and the Federal Reserve, the euro area’s central bank hasn’t cut its benchmark rate this year.