Bonds: First UK gilt auction since Brexit vote sees strong demand

UK gilts gained ground on Tuesday following uninspiring services data, while the government’s first auction since the vote to leave the European Union attracted healthy demand.

The yield on 10-year gilts fell three basis points to 0.800% as the Markit/CIPS UK services purchasing managers’ index fell to 52.3 in June from 53.5 in May, missing expectations for a reading of 52.7 and matching the 38-year low hit in April amid a darkening outlook and worries about the EU referendum.

Growth over the second quarter as a whole was the weakest since the first quarter of 2013 when the current upturn began, while the 12-month outlook was the darkest since December 2012.

Companies said uncertainty linked to the EU referendum had weighed on workloads and incoming new business.

The data collection window for the June survey was 13-28 June, with 89% of responses received before 24 June

The volume of new business received by UK service providers rose at a slightly faster rate in June, but the increase was still the second weakest seen since the upturn began three-and-a-half years ago.

Also in the UK, investors were reacting to the release of the Bank of England’s Financial Stability Report, which revealed the central has decided to loosen UK banks’ requirements to hold extra capital and warned that risks from the country's Brexit vote had already started to "crystallise".

In its twice-yearly report, the BoE looked to encourage banks to keep lending by trimming the countercyclical capital buffer rate to 0% from 0.5% with immediate effect and until at least June 2017.

It said the cuts to capital buffers will raise banks’ capacity for lending to UK households and businesses by up to £150bn.

Meanwhile, the first gilt auction since the UK’s decision to leave the EU – which was delayed by an hour so it wouldn’t clash with the FSR – attracted strong demand from global investors on Tuesday, as the government sold £2.5bn of bonds maturing in 2021 at record-low interest rates.

The average accepted yield on the five-year gilt came in at a record low of 0.377% compared to 0.863% at the 1 June auction, while the bid-to-cover ratio was 1.8 compared with 1.6 previously, showing solid demand as investors look for somewhere safe to park their cash in times of post-Brexit uncertainty.

Atif Latif, director of trading at Guardian Stockbrokers, said: “There has continued to be a flight out of equities as outflows accelerate and re-enter the fixed income market. Given the demand and record low yields it continues to show that we are seeing a prolonged and sustained outlook of little or no growth.

“Of the £2.5bn gilt auction the bid to cover (1.8) showed strong demand and thus more central bank action will be evident. Now with investors effectively paying to hold onto fixed income positions and most central banks starting to trend to negative yields global growth metrics do not look good.”

Elsewhere, German bunds advanced on their safe-haven appeal, with the 10-year bund down to -0.16%.

It was a different story in Italy, however, where government bonds lost out amid concerns about a potential banking crisis. The yield on the 10-year government benchmark bond rose two basis points to 1.265%.

Italian banks were under pressure again, with Banca Monte dei Paschi di Siena sharply lower amid reports Italy is considering a capital plan for the bank that includes selling new convertible bonds to the government and injecting at least €3bn.