UK government bonds lag behind the US and Europe

Opinions on UK government bonds this year remain mixed, as a slowdown in the US economy weighs against domestic factors such as rising house prices and the possibility of interest rate rises.

Philip Laing, head of UK government bonds at Standard Life Investments, says while he is reasonably positive on bonds generally, he favours the US and Europe to the UK.

He says if other bond markets rally this year, gilts may go with them but he expects they will lag. He adds: "Gilts run into a difficult category for us. It is pretty hard for interest rate policy to be completely removed from domestic factors such as inflation and what is going on in the property market, with the hope that the US slowdown comes to the UK.

"So we are a bit more agnostic about the UK in terms of interest rate policy. Probably rates are going to have to go higher, maybe higher than the market likes to think, and that means UK government bonds are going to be an awkward performer.

"We are more happy to pursue short-end dated bonds and 10-year bonds in other markets."

Stuart Thomson, fixed income fund manager at Resolution, says there is no possibility of interest rate cuts in the foreseeable future but the Bank of England may be forced to raise rates if wages respond to last month's inflation figures, which showed Retail Price Inflation was up to 3.9%. He adds: "The Bank believes the increase in the labour force through immigration and base effects from last year's oil price rises will tend to cool any inflationary pressures by the middle of the year."

Thomson says as a result, the short end of the market is in a very tight range for this year. But he adds the middle part of the yield curve will be more influenced by international factors. He says: "During the second quarter there will be a couple of interest rate cuts to ensure a soft landing in the US economy, which suggests that from the first half of the year we should see a modest rally for 10-year gilts, before the recovery in the US economy causes yields to rise in the second half of the year."

In terms of ultra long gilts, Thomson predicts pension fund demand could tail off. He says: "Pension fund demand for gilts and the switching out of equities into bonds has been continuing apace over the last couple of years, however, we believe it has reached extreme levels.

"If you look at the ultra long yield levels in real terms it is effectively uneconomic for pension funds to maintain that switch so we believe there is a clear risk that yields will rise at the longer end, disinverting the yield curve to some extent."

David Tolvin, fixed income product specialist at Threadneedle, says his view is fairly neutral for UK government bonds. He says while issues in the UK such as wage inflation may encourage the Monetary Policy Committee to raise rates, global factors such as rate cuts in the US are also likely to have a knock-on effect.

Denis Gould, head of UK fixed income for Axa Investment Managers, expects government bonds to return 5%-8% this year. He says: "Although these numbers may not look particularly exciting it is worth bearing in mind that, in my opinion, there is really no asset that looks outstandingly cheap at present, making the low risk returns on bonds an attractive option."

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