(Refiles to add word 'pound' to 13th paragraph and 'pounds'
to 14th paragraph)
By Kirsten Donovan
LONDON, April 20 (Reuters) - Euro zone government bonds have
underperformed U.S. and UK debt due to the European Central
Bank's reluctance to adopt the sort of quantitative easing used
elsewhere but they should fare better in the next 12 months.
For one thing, economic recovery could be slower to take
hold in the euro zone because the ECB has dragged its feet on
unconventional easing, and that is expected to mean that euro
zone interest rates will have to stay lower for longer --
capping euro zone bond yields.
Moreover, countries that have gone down the path of printing
money to shore up growth are expected by analysts to be the
focus of concerns about eventual price pressures and see their
bond markets underperform.
While the prices of longer-dated UK gilts and U.S.
Treasuries have risen as the Bank of England and Federal Reserve
effectively act as guaranteed buyers of government bonds, they
risk sharp reversal once the central banks leave the market.
"It looks like the European Central Bank will continue to
drag its feet compared to the Fed and BoE and that on balance
should help Bunds relative to Treasuries in the medium term,"
said Nick Stamenkovic, rate strategist at RIA Capital Markets.
"The ECB at the very least will cut the refi rate to 1
percent next month ... but it looks unlikely they'll follow the
path of the Fed and BoE by pursuing QE, consequently inflation
fears are likely to remain heightened in the U.S. and UK
relative to the euro zone."
Investors must wait until next month to see what alternative
policy measures the ECB adopts, but the view is that outright
purchases of sovereign bonds are highly unlikely, not least due
to the logistical difficulties in carrying that out.
The different policy approaches have seen the yield premium
offered by gilts relative to Bunds fall to close to zero from
around 50 basis points in early March before the BoE announced
plans to purchase up to 75 billion pounds of gilts over a
three-month period.
Similarly, the yield premium Bunds offer over Treasuries has
widened around 20 basis points to 34 basis points as U.S. debt
outperformed and yields fell after the Fed announced its own
$300 billion Treasury-buying scheme.
"Certainly for the near term at least, we think the money
printers have scope for outperformance," said Nomura rate
strategist Sean Maloney.
But longer term, the outlook is rather different.
"Like any sort of monetary easing, if QE works it should
stimulate the economy and ultimately put bond yields up longer
term, not down, so you have a conflict between short and long
term," said Morgan Stanley rate strategist Laurence Mutkin.
Relative to the size of their respective government bond
markets, the BoE's 75 billion pound QE programme is seen as a
shorter, sharper shock than the Fed's $300 billion programme.
Morgan Stanley estimates that by June the BoE will have
purchased 27 billion pounds more Gilts than the UK Debt
Management Office will have issued.
"We suspect that as we get towards June, the Gilt market
will get nervous its biggest buyer is going to evaporate," said
Calyon rate strategist David Keeble.
"Gilts are trading flat to Bunds at the moment which isn't
sustainable given the UK economy looks to be so far ahead in its
recovery than the euro zone which seems to be lagging the whole
economic cycle."
HIGHER YIELDS AHEAD
Bunds are expected to underperform their U.S. and UK
counterparts on a six- to 12-month horizon, according to a
Reuters poll which asked fixed income strategists where they saw
U.S., European and UK 10-year bond yields over this period.
The yield spread between 10-year gilts and 10-year Bunds is
seen widening to 15 basis points in six months time and 30 basis
points in one year as gilt yields are forecast to rise faster
then Bund yields.
The 10-year T-note/Bund spread is seen narrowing to 20 basis
points in six months and 10 basis points in 12 months as
currently lower yielding Treasuries underperform.
Certainly analysts don't see a protracted period of low
government bond yields as was the case after Japan's ill-fated
attempt at QE at the start of the decade as governments and
central banks have been much quicker to leap into action during
the current crisis.
Against this back drop, investors will find it even more
crucial to differentiate between the main government bond
markets as the effect of government and central bank stimulus
programmes begins to be felt.
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