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Investors snap up UK debt as ‘Brexit’ fears ease

Robust demand for a multibillion-pound sale of UK government debt and a rally in sterling appeared to show that investors are more upbeat about Britain’s June vote on whether to remain in the European Union.

The £4.75 billion ($6.9 billion) debt sale on April 26 attracted £21 billion of orders, according to a notice by banks underwriting the deal. The pound rose to $1.4582 in late New York trading, its highest level against the dollar since early February.

The currency has rallied over the past week as recent opinion polls showed the UK leaning toward a vote to stay in the EU and after President Barack Obama warned last week that exiting the bloc would hurt Britain’s global standing.

Concern that a vote to leave the EU, known as “Brexit,” would hit the British economy has helped push the pound down 1% against the dollar and roughly 5% against the euro this year. Still, the exchange rate has been volatile, and analysts said further market moves could come ahead of the June 23 vote.

“As the odds of Brexit have fallen, sterling has outperformed,” said Mike Riddell, a portfolio manager at Allianz Global Investors, who said the British pound has been the best-performing currency in global markets over the past five days.

“I don’t think that the gilt market was ever going to be where you see any kind of panic,” he said, referring to UK government bonds. Trading in government debt and the country’s main stock market has been mainly unaffected by speculation over the UK vote.

Proponents of the UK staying in the EU say an exit would badly damage Britain’s economy by hitting its trading relationships with the rest of the world and making it a less attractive place for foreigners to invest. Those calling for an exit, said the UK economy will thrive when it is freed of EU regulation, and new trade agreements would be forged.

In the April 26 sale, the UK’s Debt Management Office doubled the size of an existing £4.75 billion bond issue that pays an interest rate of 2.5% and matures in 2065. The bonds on Tuesday were priced to yield 2.29%, according to the office, at the lower end of what bankers had expected and a sign of strong investor appetite for the debt.

The bond sale also may have benefited from investors’ hunt for government debt that offers a positive yield. That is particularly true for UK pension funds, which need to hedge long-dated liabilities. Almost a third of investment-grade sovereign debt is now trading at a negative yield, according to Citigroup.

Bond investors have been divided on what they believe will be the impact of the vote’s outcome on gilts. Foreign investors sold gilts at the start of the year, but support has been strong from domestic investors, who bought about 92% of the April 26 bond sale, according to the UK debt office.

This year, UK government bonds have moved alongside a global rally in sovereign debt, as investors look for safety amid uncertainty over the global economic outlook. Rising prices have pushed the yield on 10-year gilts 0.3 percentage point lower this year, settling at 1.66% on April 26. Bond yields move inversely to prices. In comparison, German 10-year bonds yielded 0.3% Tuesday, while 10-year US treasuries yielded 1.93%.

Still, 10-year yields have ticked up from a recent low of 1.32% on April 7, as investors’ concerns over the global economy ease.

While investors are split on how gilts will react to a potential UK exit, the effects on the pound have been more clear-cut.

Sterling hit a seven-year low against the dollar shortly after the date of the EU vote was announced in February.

“On the currency side, it is pretty straightforward: If there is [going to be] a Brexit, sterling should go on [falling],” said Tanguy Le Saout, head of European fixed income at Pioneer Investments. “If it has a lower probability, sterling should come back some.”

Investors expect trading in the pound will stay volatile ahead of the vote. Despite the April 26 gains, short-dated currency options to protect against a sharp move in the pound are at their most expensive since 2010.

The gilt sale came ahead of a report due on April 28 that is expected to show the UK economy lost momentum in the first quarter after expanding in 2015 at the second-fastest pace among the Group of Seven leading nations after the US. A renewed manufacturing slump as well as uncertainty over the outcome of June’s referendum are both weighing on growth, economists said.

Officials at the Bank of England have warned that the economy could slow further in the months ahead as doubts about Britain’s future in Europe intensify. The central bank’s rate-setting Monetary Policy Committee in April highlighted a range of potential vulnerabilities to referendum jitters, including hiring, business investment, real-estate transactions and consumer spending.

Write to Christopher Whittall at christopher.whittall@wsj.com and Jason Douglas at jason.douglas@wsj.com

This article was published by The Wall Street Journal

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