U.K. Bond Rates Lower Than Japan’s Warn Economic Pain to Drag On

The U.K. now offers lower returns on its debt than its Japanese peers, the latest sign investors are betting on further interest-rate cuts to stave off a deep recession.

The yield on the U.K.’s two-year bonds declined to an all-time low of minus 0.129%, inverting the spread between the nations’ securities for the first time on record, based on generic benchmark rates. The gaps on five- and 30-year bonds aren’t far off zero.

U.K. Bond Rates Lower Than Japan’s Warn Economic Pain to Drag On

That comes after U.K. growth figures for May missed estimates on Tuesday, showing the economy’s struggle to recover from the coronavirus lockdown and driving investors into havens such as gilts. Meanwhile, shorter-dated Japanese bonds have been backstopped by the country’s central bank, keeping yields steady.

“Unlike Japan, we don’t really know where the bottom is for GBP rates,” said Antoine Bouvet, a rates strategist at ING Groep NV. “Granted we are still some months away from a potential decision to slash interest rates below zero but if the euro zone or Switzerland is the template, then there is potential for GBP rates to go much lower than their JPY counterparts.”

The Office for Budget Responsibility sees the nation’s budget deficit widening to as much as 21% of gross domestic product, according to a report published Tuesday. The economy may shrink by at least 10% this year, and as much as 14.3% if the OBR’s worst-case scenario pans out.

BOE Warning

The moves show that European debt markets may be undergoing “Japanification,” a world of low yields, tepid inflation and little volatility. Some bond traders are speculating that the Bank of England could also follow its Japanese equivalent in trying to limit borrowing costs via so called yield-curve control.

“This development signifies that while Japan has long been at the vanguard of unconventional policy making, it has been a harbinger of things to come rather than an outlier,” said Richard McGuire, the head of rates strategy at Rabobank in London. “We have argued for some time that Japanification has been underway in the West.”

U.K. Bond Rates Lower Than Japan’s Warn Economic Pain to Drag On

Other market indicators have also flashed signals that the BOE could follow Japan’s crisis policy making. Rate futures tied to three-month sterling Libor traded above 100 for the first time last week, hinting at negative rates by March 2022. A day earlier, the rate banks use to lend to each other dropped below the BOE’s benchmark, a move that often precedes a rate cut.

BOE Governor Andrew Bailey fueled the debate further by warning lenders last month of the challenges negative interest rates would bring. He’ll address lawmakers from the U.K.’s ruling Conservative Party on Wednesday, where he may be asked about the consequences.

Trading hours for both nations’ debt only coincide for an hour between 8 a.m. and 9 a.m. London time.

©2020 Bloomberg L.P.

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