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UK Gilts report. 3rd Quarter 2009.

Report by F&C Investments:

With interest rates at 0.5% since March and scope for further easing unlikely, the incentive for short dated gilts to rally further is limited. The Bank of England’s (BoE) quantitative easing has buoyed prices recently but with the latest tranche of the buyback expected to end in July (and a limited ?25bn of potential gilt purchases left in the BoE’s armoury), quarterly issuance is expected to average circa ?55bn over the remaining fiscal year. This deluge of new issuance is expected to weigh on longer dated conventional gilt yields. Index-linked bonds have fared better, with yields remaining fairly steady against the backdrop of a supportive issuance calendar and inflation concerns.

However, the recent rise in yields appears excessive given the strains on growth. Any economic recovery is likely to be tepid and we expect to trade duration on a tactical basis. With curves historically steep, we also have a tactical curve flattening bias, remaining overweight 15-year to 25-year gilts, which are the focus of the BoE’s quantitative easing programme. We also hold a small proportion of our gilt exposure in index-linked bonds as a hedge against inflation risk.