December 27, 2013 9:45 pm

Gilt yields rise above 3 per cent as economic optimism rises

Benchmark UK borrowing costs rose to their highest for more than two years on Friday as investors bet on brighter economic prospects in 2014.

Ten-year UK government bond yields, a bellwether for interest rates across the economy, broke the 3 per cent mark on Friday, climbing from 2.97 per cent to 3.07 per cent, the highest since July 2011.

The latest move in Gilts caps a year of steadily increasing UK yields, from 1.82 per cent at the beginning of January, as confidence in the economy grew on the back of buoyant house prices and a resurgent stock market. As the economy strengthens, investors typically demand higher yields to compensate for the increased risk of inflation.

The UK shift coincided with a climb in the benchmark 10-year US government bond yields above 3 per cent in the wake of the US Federal Reserve’s decision on December 18 to begin cutting its massive bond purchases to support financial markets.

“The rise in Gilt yields shows there’s a recovery dynamic in place,” said Suki Mann, an analyst at Société Générale. “It’s a function of both taper-induced contagion from the US and also clear signs of hopefully sustainable economic growth.”

The US 10-year yield has climbed from 2.80 per cent since the Fed’s decision. Many Wall Street strategists expect it will reach 3.50 per cent or higher in the coming months.

“Investors do not want to own Treasuries at the moment, the preference is for equities and corporate bonds, while the bond market also faces absorbing more debt next year under the Fed’s taper,” said William O’Donnell, strategist at RBS Securities.

The FTSE 100 index of the one hundred largest companies on the London Stock Exchange has risen by nearly 15 per cent for the year to date putting it on track for its best annual performance since 2009, when it rose 22 per cent. The index closed 0.8 per cent up at 6750.8 on Friday.

Supported by a surfeit of liquidity in the global financial system, the index’s advance has been led by two airline stocks, International Consolidated Airlines Group and EasyJet, both of which have doubled in value. However, the index is still short of its record high of 6,950.6, recorded in December 1999.

In spite of the rosier economic outlook, analysts warn that dangers to economic growth remain, particularly if financing costs rise steeply on the back of higher Gilt yields.

“Higher Gilt yields could be reflected in higher financing costs for smaller companies.” said Mr Mann. “That could act as a limiting factor on the pace and quality of the economic recovery.”

Earlier this month Mark Carney, the Bank of England governor, warned that there was “a great risk” associated with the tapering of central banks’ asset purchasing programmes.

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