Demand for corporate bonds increases

Demand for low-risk assets remained strong during August amid intensifying fears the global economic recovery is losing impetus.

According to the Investment Management Association, bonds continued to outsell equities with Sterling Strategic Bond the second most popular sector during June while Sterling High Yield outperformed all other bond groupings over the previous 12 months.

Meanwhile, UK gilt prices extended their rally and yields fell as investors became more sanguine that UK interest rates would remain at their current exceptionally low levels, increasing the attraction of fixed-income securities.

The UK economy grew more quickly than expected during the second quarter of 2010. UK gross domestic product expanded by 1.2%, according to the Office for National Statistics (ONS), driven by renewed activity in the construction sector and inventory restocking by companies. However, growth in services, which make up a significant proportion of the UK economy, was revised down from 0.9% to 0.7%.

The rate of employment in the UK rose to 70.5% during the second quarter, increasing by 184,000. According to the ONS, this was the largest quarterly increase in the number of people in employment since 1989, although the rise was fuelled primarily by an increase in part-time workers.

The British Chambers of Commerce expects the Bank of England (BoE) to maintain UK interest rates at their current low level of 0.5% until the second quarter of 2011 and also suggests the planned cuts in government spending will increase the likelihood of a double-dip recession.

Meanwhile, speculation about the future path of UK interest rates remains lively, although the BoE remained tight-lipped about its plans, merely stating its rate-setting Monetary Policy Committee was “ready to respond in either direction as the balance of risks evolved”.

According to the ONS, the rate of UK inflation grew by 3.1% during July, year on year, having registered growth of 3.2% during June. Lower prices for transport, clothing and footwear caused the slight drop. BoE governor Mervyn King believes UK inflation could continue to surpass the Government’s upper limit of 3% in the short term, but expects inflation to fall below the bank’s rolling 2% target during 2012 “as persistent spare capacity weighs on companies’ costs and prices”.

In the BoE’s most recent Quarterly Inflation Report, King also warned that tight credit conditions and budget cuts are likely to hamper economic growth, sparking fresh fears the UK economy might need additional emergency stimulus.