LONDON (Reuters) - British gilt futures slid with German Bunds on Friday as investors took profits following recent gains and markets waited for progress on how policymakers will tackle the euro zone sovereign debt crisis.
Worries about Europe's plight have eroded risk appetite, boosting British government debt and pushing its benchmark bond yields close to record lows this month.
By 12:14 p.m., December gilt futures were 71 ticks down on the day at 130.22, underperforming the equivalent German Bund future by around 25 ticks.
In the cash market, the yield on 10-year gilts was up by 11 basis points at 2.26 percent. The yield spread over Bunds had earlier been in negative territory for a second day, suggesting investors view UK government bonds as a safer bet. By the middle of the session, the spread was back just above zero.
"We've had a very good run and I expected we would see a bit of profit-taking. We didn't really get it yesterday, and now today it's kicking in," said Lloyds strategist Eric Wand.
Gilts volumes were thin, however, and appeared to be led by the futures market, he added.
Analysts said UK government bonds still had scope to outperform Bunds because the euro zone crisis is far from over.
Italy paid a record 6.5 percent to borrow over six months on Friday, following a dire German debt auction on Wednesday that raised fears investors are worried about contagion to Europe's biggest economy.
Gilts will also receive support from the Bank of England's 75 billion pounds second round of gilts purchases. The scheme is designed to stimulate the economy and avoid a period of deflation caused by weak growth and many analysts think the central bank could expand it again in the coming months.
"Fundamentally there are still reasons for gilts to outperform Bunds, given (Wednesday's) poor auction for Bunds and the clear lack of demand for European government bonds," said a London-based trader.
The Office for Budget Responsibility, Britain's independent fiscal watchdog, is expected to cut its UK growth forecasts in half next Tuesday when Chancellor George Osborne delivers his budget announcement in parliament. However, the reaction in the gilts market may be muted.
"It should be anticipated," Lloyds' Wand added. "But we will probably still get a knee-jerk negative reaction."
Analysts at RBS said the euro zone crisis was "gradually nibbling at the core EMU (states)," giving a lift to British and American government bonds.
"A significant slowdown in the global economy now seems near-certain (and) yet another reason for gilts and Treasuries to continue outperforming," they said in a research note.
With no UK data on the agenda, the sole domestic focus for the market will be a speech by Bank of England policymaker Martin Weale at 1 p.m.