A Possible Brexit, a Weak Pound, and an Outperforming U.K. Gilt Bond Market

Year-to-date, the U.K. gilt market has performed the best out of all of Europe’s safe-haven government bond markets.  The S&P U.K. Gilt Bond Index has returned 6.15% YTD, one of the highest in Europe.  Yields in U.K. gilts have tightened by 41 bps since the beginning of this year, with the S&P U.K. Gilt Bond Index yielding 1.36% as of June 1, 2016.  U.K. gilts are still seen as a safe haven despite concerns that the U.K. might elect to exit the European Union.  Concerns over a possible exit have put the pound near its seven-year lows versus the USD.  At the end of Q1 2016, GDP growth in the U.K. slowed to 0.4% from the 0.5% growth seen in the previous quarter, while annual growth was revised down to 2%.

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U.K. polls offer no clear sign as to which direction the June 23, 2016 referendum will take.  Uncertainty often leads to a flight to safety, and the U.K. gilt market continues to be seen as a safe haven.  If a Brexit is voted for and uncertainty in the U.K. economy loom, U.K. gilts could benefit further (prices continue to rise and yields fall), as the Bank of England could keep rates low for longer.  Alternatively, if the British pound weakens significantly as a result of a Brexit, there could be a foreign capital flight out of the U.K.  This could cause a spike in inflation as import costs increase, thus encouraging bond yields to rise.

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