UK debt costs below U.S. costs for first time in 2 years

U.S. politicians were due to vote later on Thursday on a deal to lift the country's debt ceiling before an August 2 deadline to avoid default. But even if a deal is reached, a budget plan that does not include hefty deficit cuts may result in a downgrade of the United States' top-notch credit rating.

Worries that last week's bailout plan for Greece would not be enough to stop the euro zone debt crisis spreading have added to gilts' appeal as a safe harbor.

At 1045 GMT (6:45 a.m. EDT), September gilt futures were 30 ticks up at 124.21, having hit a session high of 124.46 -- within a whisker of a new contract high.

In the cash market, the yield on 10-year gilts was down 2 basis points at 2.961 percent, having earlier come within sight of an eight-month low at 2.931 percent.

That left the spread against U.S. Treasuries at -3 basis points -- the first dip into negative territory since August 2009, when the Bank of England was expanding its quantitative easing program to buy assets, according to analysts.

While most analysts hope a default will be avoided by an eleventh-hour deal, the risk remains for a damaging downgrade of the United States' top-notch credit rating, a move that would raise U.S. borrowing costs and rattle global investors.

September gilt futures settled 16 ticks up at 124.07, having hit a session high of 124.46 -- within a whisker of a new contract high.

"The U.S. is at risk of a downgrade if they don't sort their lives out, which they don't seem to be doing. Things may change overnight if we get some miraculous passage through the House of Representatives," said Eric Wand, strategist at Lloyds.

"Set against that, the UK is perceived to be on the front foot in terms of its approach to its longer-term fiscal problems... The UK is a valid option for that (investor) money looking for a home."

In the cash market, the yield on 10-year gilts was down 1 basis point at 2.97 percent, having earlier come within sight of an eight-month low at 2.931 percent.

That left the spread against U.S. Treasuries at -3 basis points -- the first solid dip into negative territory since October 2009, according to Thomson Reuters data.

"During the course of 2011, the spread has been fairly steady at between 10 and 30 basis points," said Sam Hill, strategist at RBC Capital Markets. "So the fact we've broken out of that range gives an indication of the magnitude of the impact of the uncertainty about the debt ceiling issue."

In recent sessions, demand for gilts has been mainly in futures, indicating that trades were merely speculative, but analysts said more investors were starting to pile into the cash gilt market, suggesting a more fundamental shift in view.