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March 27 (Bloomberg) -- The best start to a year for U.K. government bonds since the Asian financial crisis risks running out of steam, say investors managing more than $2 trillion.
Gilts are on course for their strongest first-quarter performance since 1998 after the 10-year yield dropped 34 basis points this year, according to Bank of America Merrill Lynch indexes. Standing in the way of further gains are a strengthening U.K. economy and rising Treasury yields.
“Gilts have probably done enough for now,” said Andrew Wickham, the London-based head of U.K. and global fixed income at Insight Investment Management Ltd., which has assets of $453 billion. “The market is no longer cheap. We’re now at levels which are closer to fair value given our outlook for interest rates.”
The 10-year yield will end the second quarter at 3 percent, according to the median of 25 forecasts in survey compiled by Bloomberg. The government benchmark was at 2.68 percent as of 10:18 a.m. London time, 114 basis points more than equivalent German debt.
The Office for Budget Responsibility, Britain’s fiscal watchdog, raised its 2014 growth forecast to 2.7 percent last week, prompting investors to boost bets the Bank of England will increase borrowing costs next year from a record-low 0.5 percent.
Consumers buoyed by a surging housing market and rising employment are driving Britain’s recovery, with the central bank forecasting last month that household-spending growth will accelerate to more than 3 percent this year. U.K. retail sales rose more than three times as much as economists forecast in February as spending on food surged, a report showed today.
The Bank of England is now seen increasing its benchmark rate a quarter point next March, two months earlier than projected a week ago, according to one-month forward Sonia contracts.
Offsetting the pressure on BOE policy makers is an inflation rate that fell to a four-year low of 1.7 percent in February, the second straight month below their 2 percent target. Investors also anticipate an economic slowdown in China and political crises from Thailand to Ukraine will underpin demand for safe assets such as gilts.
“Forward-looking surveys remain strong, the U.K. housing market is very buoyant and the growth outlook over the short- medium term looks relatively decent,” said Michael Riddell, a London-based fund manager at M&G Group Plc, who helps oversee about $405 billion. “On the other hand the outlook for U.K. and global inflation is benign and geopolitics is boosting the safe- haven bid. A broadly neutral positioning for now makes sense.”
Much may depend on events in the U.S., where yields on government securities surged last week after Federal Reserve Chair Janet Yellen indicated officials could begin raising the key rate, which has been close to zero since 2008, next year.
Treasury yields dipped yesterday as a drop in business- equipment orders cast renewed doubt on the pace of U.S. growth after harsh winter weather hit the economy earlier this year.
The 10-year yield was at 2.70 percent today, and is projected to reach 3 percent by the end of June, based on the median of 71 forecasts compiled by Bloomberg.
“The key thing for gilts is not what happens in the U.K. over the next three or six months,” said Azim Meghji, head of U.K. fixed income at Santander Asset Management, which oversees $31.5 billion. Gilt yields are at “the appropriate level for now,” he said.
U.K. government bonds matched the performance of German debt this quarter, even as speculation the European Central Bank would need to add stimulus boosted demand for bunds. According to Bloomberg World Bond Indexes, gilts returned 2.6 percent this year and German bonds gained 2.5 percent. Treasuries rose 1.8 percent.
That’s put gilts on course for the biggest gain in the opening quarter of a year since 1998, when investors seeking a haven from the Asian crisis helped the securities return 4 percent.
Ten-year yields are forecast to end 2014 at 3.40 percent, according to the Bloomberg survey. That’s up from a projection of 3.36 percent in an equivalent survey at the end of last year.
“The 10-year part of the gilt curve looks at little bit rich at the moment,” said Iain Stealey, a portfolio manager at J.P. Morgan Asset Management, which oversees $1.6 trillion. “We’re trying to avoid bonds in those types of areas.”