Gilts Gain as Europe Debt Crisis Spurs Safety Demand

U.K. government bonds gained for a second week and the pound strengthened versus the euro amid signs the euro-region debt crisis is deepening.

Ten-year gilt yields dropped to the lowest in six weeks as Moody’s Investors Service downgraded Italy’s bond rating by two levels and reiterated its negative outlook. Sterling climbed to the strongest since November 2008 against the euro as investors bet the U.K. economy will outperform after the Bank of England released details of a new lending program to limit contagion from the single-currency area.

“People are very nervous over the outlook in the euro region,” said Charles Diebel, the head of market strategy at Lloyds Banking Group Plc in London. “That continues to drive demand for gilts.”

The U.K. 10-year yield fell four basis points, or 0.04 percentage point, this week to 1.55 percent. The 4 percent bond due in March 2022 gained 0.395, or 3.95 pounds per 1,000-pound face amount, to 121.875. The yield dropped to 1.505 percent on July 12, the lowest level since June 1.

Gilts have returned 1.4 percent this month, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. They gained 17 percent over the past year as investors sought alternatives to euro-area assets.

Moody’s cut Italy’s government bond rating to Baa2 from A3 yesterday, saying a deteriorating economic outlook had created a risk the nation will fail to meet its budget targets.

Pound Gains
The pound rose 0.8 percent this week to 78.67 pence per euro as of 5 p.m. in London yesterday. It climbed to 78.63 pence yesterday, the strongest since Nov. 3, 2008. Sterling gained 0.4 percent over the week to $1.5550.

The U.K. currency has advanced versus the euro since the European Central Bank cut its overnight deposit rate to zero this month to encourage financial companies to lend to other institutions, companies and households.

“Sterling outperforms the euro as a safe-haven destination outside the euro zone,” said Neil Jones, head of European hedge-fund sales at Mizuho Corporate Bank Ltd. in London. “Money is flowing away from the ECB since the move to zero percent deposit rate partially into the U.K. I expect this to continue.”

The Bank of England said its new lending plan may boost credit to companies and households by at least 80 billion pounds. Banks will be able to borrow treasury bills from the central bank from Aug. 1 to fund lending into the economy, according to details of the Funding for Lending program published yesterday.

The pound has strengthened 1.8 percent this year, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-nation currencies. The euro depreciated 4.5 percent, and the dollar gained 1.8 percent.