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U.K. Yield Curve Flattest Since Financial Crisis on Brexit Fears

Bonds Prove to Be U.K. Asset of Choice as May on Brink of Exit

(Bloomberg) -- U.K. bonds are becoming the main beneficiary of Prime Minister Theresa May’s troubles as traders start betting on interest-rate cuts.

Gilts have surged to take benchmark yields to the lowest since 2017, as investors sought safe assets on the increasing risk of a no-deal Brexit. By contrast the pound has notched up its longest-ever losing streak against the euro and U.K. stocks are headed for their biggest monthly slide in 2019 as trade-war concerns add to Brexit chaos.

U.K. Yield Curve Flattest Since Financial Crisis on Brexit Fears

Gilts have outperformed their peers in May, including Treasuries and German bunds, on the prospect that the Bank of England might have to switch tack to make its next move a cut in interest rates. Ten-year U.K. bonds have climbed even more than two-year securities as sentiment weakens, pushing the yield curve to its flattest since the financial crisis in 2008.

“There is the growing realization that the BOE’s case for hiking is falling apart, due to prolonged Brexit uncertainty weighing on the U.K. economy,” said Peter Chatwell, head of European rates strategy at Mizuho International Plc. “The BOE has been making wildly optimistic assumptions, which they could well turn on if the PM does resign and a Brexiteer takes the helm of the Conservative Party.”

Markets are already looking beyond May’s exit following her failure to win support for new Brexit proposals this week. May is set to announce a date for her resignation Friday, with an election for her replacement starting June 10, according to people familiar with the matter. Former Foreign Secretary Boris Johnson has emerged as an early frontrunner and hasn’t ruled out the prospect of leaving the European Union without a deal at the end of October.

U.K. 10-year yields held their ground on Friday at 0.95%, the lowest level since June 2017. The premium over two-year bonds has narrowed to around 30 basis points, the lowest level in nearly 11 years.

Traders in money markets put the probability of a BOE rate cut by December at 8%, compared with a 32% chance of a hike at the start of the month. Governor Mark Carney warned at the central bank’s last decision on May 2 that the current rate curve was “unequal” to the task of tackling inflation.

“It’s only three weeks since Carney said rate hikes would come faster than the market anticipated, and since then the market’s virtually unwound everything that was priced in,” said John Wraith, head of U.K. rates strategy at UBS Group AG.

To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee, Brian Swint

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