The recent improvement in both the timeliest economic news and sentiment towards the euro-zone has led investors to question whether the exceptionally low levels of gilt yields that were reached at the end of 2011 are now justified. We still see four compelling reasons to think that they are warranted. First, we expect the economy to slip back into recession this year, reflecting further fiscal austerity, rising unemployment and the knock-on effects of a deep recession in the euro-zone. Second, inflation looks set to fall to a lower rate than many investors currently expect. Third, while QE may be becoming a less effective monetary policy tool, it should still help to pin yields down. Finally, while a double-dip will undermine the health of the UK’s public finances, gilts will continue to look one of the best of a bad sovereign bunch.
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