Osborne Austerity Seen Pushing Gilt Sales to Lowest Since Crisis

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Holders of U.K. government bonds are set to receive a boost when Chancellor of the Exchequer George Osborne announces the first Conservative-only budget in almost 19 years next week.

With the deficit narrowing faster than anticipated, Royal Bank of Canada, Scotiabank and Morgan Stanley see gilt issuance dropping this year to about 120 billion pounds ($188 billion) -- the least since the financial crisis. Sales could be pared further if the government begins to dispose of its stake in Royal Bank of Scotland Group Plc, as it indicated last month. At RBC, Vatsala Datta recommends buying longer-dated debt.

“The risk to that remit will be to the downside because we haven’t taken into account privatizations,” the London-based strategist said. “If you do see those privatization proceeds come through by the end of this year that will be taken into account in the Autumn Statement. It’s going to be a market-friendly event.”

The Debt Management Office may scale back planned sales for the fiscal year that began in April by as much as 10 billion pounds, according to RBC and Scotiabank. Morgan Stanley sees an 11 billion-pound reduction. It would leave issuance at the lowest since 2007-08 and down from a record 227.6 billion pounds in the aftermath the 2008-09 recession.

Osborne called a special budget for July 8 after the Conservatives won a surprise parliamentary majority in May’s general election, ending five years of coalition with the Liberal Democrats.

Budget Targets

His aim is to turn a budget deficit of almost 5 percent of gross domestic product into a surplus by 2018-19 by slashing 25 billion pounds from welfare and government departments in an intensification of the austerity drive he began in 2010.

Buoyant tax receipts mean Osborne is on course to beat his projections for the current fiscal year. In March, the Office for Budget Responsibility forecast the deficit would fall by about 15 billion pounds to 75 billion pounds. In the first two months, borrowing was 5 billion pounds below its level a year earlier.

“In other words,” writes Jamie Murray, a Bloomberg Intelligence economist, “a third of the improvement has been registered just a sixth of the way through the year.”


For gilt investors, there is further good news. Since the March budget, departments have agreed to deliver an extra 3 billion pounds of cuts this year. In addition, the Treasury expects to receive about 1.5 billion pounds from the sale of its 30 percent stake of Royal Mail Plc and there is the prospect of more cash as the government begins the task of returning RBS to private hands.

“The good start to the year plus the scope for front-loading of austerity could lead to a reduction in the financing requirement,” said Alan Clarke, an economist at Scotiabank in London.

With only limited scope to pare sales of short-term money-market securities, Clarke sees gilt issuance being cut by between 5 billion pounds and 10 billion pounds from the 130.9 billion pounds the DMO announced in April. In the 2014-15 fiscal year, 126.4 billion pounds of gilts were auctioned.

A cut in planned issuance could provide support for gilts, which lost almost 2 percent this year -- underperforming Treasuries and German bonds -- as the Bank of England edges closer toward its first interest-rate increase since 2007.

While Credit Suisse Group AG strategist Daniela Russell sees sales declining by just 5 billion pounds, she says that will be enough to cut the risk of failed auctions. “Slightly reducing the size of the auctions will ease some of the pressure,” she said.

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