- Median forecast from dealers is for 137 billion-pound issuance
- Royal Bank of Canada predicts a 17% increase in gilt sales
Britain is set to increase government-bond sales by the most in five years as a cooling economy and asset-sale delays hinder Chancellor of the Exchequer George Osborne’s plans to balance the books.
Gross issuance may jump 17 percent in the next fiscal year, Royal Bank of Canada said. Its estimate was the highest of analysts in a Bloomberg survey whose median was for a 7.5 percent increase. Osborne was relying on selling billions of pounds of shares in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc to help cut borrowing next year. Those deals are now in serious doubt because of market turmoil.
The scenario may get more difficult, with Britain three months away from voting on whether to leave the European Union. Osborne faces potentially higher borrowing costs and reduced tax revenue should the uncertain outcome of a so-called ‘Brexit’ put off foreign investors. They currently hold about 25 percent of gilts. He presents the budget to Parliament March 16.
“There is a risk it will show the economy doesn’t generate the tax receipts that the government has expected,” said Sam Hill, a senior U.K. economist at RBC in London. “A weaker economy has implications both on revenues and the conditions that are required to privatize the banks.”
The median of 15 estimates from gilt primary dealers was for the Debt Management Office to sell 137 billion pounds ($194 billion) of securities for the year beginning in April, compared with 127.4 billion pounds this year. The percentage increase would be the biggest since the 2011-2012 fiscal year, when issuance jumped 7.9 percent to 179.4 billion pounds. The DMO estimates that gilts maturing in the next fiscal year will be little changed at about 70 billion pounds.
Almost six years after vowing to wipe out the biggest budget deficit in British peacetime history, Osborne is being thwarted by challenges to the U.K. economy from Chinese growth to equity markets souring.
While his fiscal austerity program, to return to a budget surplus by 2020, helped bring gilt borrowing to a post-crisis low of about 126 billion pounds in 2014-2015, that relief may prove short-lived.
“Slower growth and previously rosy official projections mean the Chancellor will now have to deal with higher-than-forecast government borrowing when he presents his budget,” Bank of America Merrill Lynch analysts Rob Wood and Mark Capleton said. “What matters for the longer-term picture is whether the latest deterioration is structural or cyclical.
The government is likely to fall well short of its asset-disposal target. Plans to sell Lloyds shares in the spring were shelved in January because of market conditions. Osborne had vowed to dispose of the 9.1 percent stake, currently valued at about 4.6 billion pounds, by the end of 2016. Similarly, the chancellor may miss his goal to raise as much as 5.8 billion pounds from selling RBS shares, according to officials, who asked not to be identified because the discussions are private.
The number of U.K. primary dealers has fallen by two to 19 in the last fiscal year, and market makers said at a meeting with officials from the DMO and Treasury in January that tighter regulations are making it increasingly difficult to sell gilts.
Even so, there are few signs of a lack of demand in the secondary market. U.K. government bonds, supported by speculation the Bank of England won’t raise interest rates this year, have delivered the biggest returns this year among the major developed market economies, according to Bloomberg World Bond Indexes.
Morgan Stanley predicts that the DMO will address the need for more gilt issuance by selling more inflation-linked bonds and medium-maturity nominal debt, or securities due in 7 to 15 years. Cutting shorter- and longer-dated maturities would make sense as demand for them has been “occasionally shaky,” the bank said in a note.
While investors are divided on whether Brexit would be bad or not for gilts, tensions and uncertainty are running high in the buildup to the June 23 referendum and may be enough to dent demand.
Goldman Sachs Group Inc. and BlackRock Inc. are among those banks who’ve warned the vote puts trade and investment at risk. The latest BOE data showed overseas investors sold a net 6.3 billion pounds of gilts in January, the most since March 2014. The median of analysts’ predictions compiled by Bloomberg is for the 10-year gilt yield to end the year at 2.07 percent, up from its 1.54 percent yield on Tuesday at 4:33 p.m. in London.
“The dominant issue at the moment is ‘Brexit’ risk” in the run-up to the vote, said Mark Dowding, partner and portfolio manager at BlueBay Asset Management in London. “Were the U.K. to vote ‘Leave,’ we see a much weaker pound and this could push gilt yields higher. This could be exacerbated by perceptions that the U.K. is losing a safe-haven status in such a scenario.”
While plans to sell an RBS holding and some of the government’s Lloyds stake didn’t go as expected, analysts have speculated that the government may sell mortgages of Bradford & Bingley, which was nationalized in 2008. Treasury officials have sought advisers to assess the feasibility of privatizing some of the 26 billion pounds of mortgages currently held by U.K. Asset Resolution Ltd.
“One potential wild card -- which could lower gilt issuance sharply -- is the announcement of new asset sales, perhaps involving the Bradford & Bingley loan book,” said Jamie Searle, a strategist at Citigroup Inc. in London.
In any case, the fiscal and gilt outlook is likely to present challenges for Osborne in coming years as he struggles to meet a target of returning to surplus by 2020.
The borrowing outlook “has probably deteriorated rather than improved,” said Simon Peck, a rates strategist at Royal Bank of Scotland. “That will probably manifest itself in some degree of upside revision to financing projections over the coming few years.”