(Bloomberg) — UK government bonds posted their first weekly advance in over a month, emboldening strategists and investors who say a rally is just getting started.
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While the market suffered a fresh bout of losses on Friday after the US reported much stronger-than-expected jobs data, the yield on 10-year bonds ended the week five basis points lower. Investors were bolstered by the prospect of rate cuts and a further slowdown in inflation.
Mizuho International Plc is recommending investors buy the dip, saying a deceleration in consumer price growth to 2% will put gilts into “full rally mode” by the second quarter. Baring Investment Services Limited has been adding to their position this year, betting that contrary to market expectations, weak growth and soft inflation will lead the Bank of England to cut rates faster than the Federal Reserve.
“We are confident that growth will be very weak. We are confident that inflation will have fallen even more. So when we look at gilts, they offer you extremely good value,” said Brian Mangwiro, a fund manager at Baring Investment Services Limited. “It’s probably one of the markets where we’ve added more” this year.
Traders are currently betting on about four quarter-point rate cuts in the UK this year, compared to five in the euro area and the US. In terms of timing, they see a big chance of the ECB moving in April, while the Fed is expected to start in May and the BOE in June.
“While not rushing, the BOE is preparing to cut, likely adding support to the bullish turn in global duration,” said Citi strategists including Jamie Searle.
Yet a more benign inflation outlook could prompt the market to bring forward the expected start-date for cuts, putting the UK’s central bank more in line with the peers and offering the bond market an added boost.
Officials in UK now believe inflation will fall to its 2% target in the second quarter thanks to tumbling energy prices. That’s more than a year earlier than the BOE projected at its last forecasting round in November, and led policymakers to open the door to interest-rate cuts this week. They also dropped their guidance that borrowing costs may have to rise again.
UK bonds “may go on full rally mode into the second quarter, when CPI is expected to temporarily fall below 2%,” said Evelyne Gomez-Liechti, a multi-asset strategist at Mizuho, who recommends investors buy gilts on dips.
Why Bank of England’s Interest Rate Cuts May Lag Fed and ECB
That’s not to say the trade is without risks. Citi notes attention will next turn to the March 6 budget for any stimulus from Prime Minister Rishi Sunak’s government. Chancellor of the Exchequer Jeremy Hunt wants to find room for tax cuts, and a push to loosen fiscal policy could spook the market.
The BOE also expects inflation to bounce back to almost 3% as the impact of cheaper energy fades and underlying price pressures in services and wages persist, potentially undermining the market’s bull case.
Still, it’s likely that “rate cuts will need to be brought in sooner rather than later,” said Lindsay James, investment strategist at Quilter Investors . “The UK economy is in somewhat of a malaise, and rates at this level for too long may end up being overly constrictive.”
–With assistance from James Hirai, Alice Atkins and Sujata Rao.
(Updates prices.)
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