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Switch to EIB amid Greek tragedy for gilts

Created:

2 December 2009

Written by:

Mark Glowrey

Given the bloated state of the Gordon Brown's public-sector finances, there is considerable speculation from market commentators that the UK may lose its long-held triple-A rating from the credit agencies. There is some logic to this argument, given that Italy's rating stands at A+ and Japan at AA.

Indeed, a recent research note from Morgan Stanley's European strategy team expressed the concern that a hung parliament would increase the likelihood of the rating agencies removing the UK's AAA status. The economic Cassandras go on to point out that if things get really bad, a full-scale fiscal crisis would lead to a sell-off in gilts and sterling, with the Bank of England raising rates in an attempt to defend the latter.

MS's team believe that this kind of event would push gilts up around 150 basis points, to over 5 per cent, more than the yield on Greek government bonds. In that scenario, credit spreads could go negative - meaning good-quality sterling corporates and other bonds might become more desirable than gilts.

Could this really happen? I certainly would not dismiss the possibility. To a degree, UK investors can diversify against currency depreciation by holding overseas assets, and many investors have already done this. However, the threat to UK government credit spreads is also something to consider. Investors with sizable gilt portfolios should consider switching some of their holdings into alternative highly-rated sterling bonds, if only as a precautionary move.

In some ways, this is an attractive trade in its own right. The AAA-rated European Investment Bank offers a range of maturities for sterling investors. Whilst the depth and liquidity of these bonds is less than that seen in the gilt market, the incremental yield offered is fairly generous. Look at the EIB 4.125 per cent 2017 issue, for instance - it has a yield to maturity of 3.66 per cent. That compares well with comparable gilts such as the Treasury 4 per cent 2016, which yields only 3.04 per cent.

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Daily prices, charts and data for gilts, linkers, corporate bonds and Pibs - now includes downloadable prospectuses for Pibs issues!

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