Not the Week to Be Long Gilts as U.K. Debt Seen Climbing

Analysts’ predictions that Britain will refrain from increasing gilt sales this year are offering little comfort to investors, who drove yields up the most in six weeks amid a deteriorating outlook for public finances.

U.K. government bonds tumbled before the Debt Management Office issues revised financing plans tomorrow. That announcement will come after Chancellor of the Exchequer George Osborne presents his end-of-year outlook to Parliament in London starting at 12:30 p.m. The so-called Autumn Statement is his last before a general election in May that polls show is too close to call.

Far from narrowing as officials predicted in March, the budget shortfall has widened since April as the recovery fails to lift tax receipts. With stagnation in the euro region now also weighing on the U.K. economy, the Office for Budget Responsibility could add as much as 75 billion pounds ($117 billion) to its deficit projections for the next five years, according to UBS Group AG.

“It’s a bit alarming that borrowing is not coming down more quickly,” said John Wraith, head of U.K. rates strategy at UBS in London. “At the margins, it might make the gilt market trade a bit heavily just on this endless upward revision to future years of borrowing.”

Survey Results

The yield on 10-year gilts jumped eight basis points, or 0.08 percentage point, to 1.98 percent at 3:50 p.m. London time, the biggest increase since Oct. 17. The 2.75 percent gilt due in September 2024 fell 0.715, or 7.15 pounds per 1,000-pound face amount, to 106.845.

The 10-year rate had fallen to 1.86 percent yesterday, the lowest since May 2013.

“There’s a bit of a defensive positioning ahead” of tomorrow’s statement, said Vatsala Datta, a strategist at Royal Bank of Canada in London. “Even though we are not expecting any change in the gilt remit for this year, it will have implications over the coming four or five years.”

The Debt Management Office will issue 127.2 billion pounds of bonds in the fiscal year ending in March, unchanged from plans made earlier this year, according to the median estimate of 18 primary dealers that trade directly with the government agency. Instead, it will increase sales of Treasury bills -- debt that matures in a year or less -- to meet extra borrowing needs totalling as much as 10 billion pounds, the survey found.

Larger, Painful

The possibility of higher-than-anticipated issuance comes at a time when economists see the Bank of England raising its benchmark rate from a record-low 0.5 percent next year. Gilts are among the best-performing developed bond markets this year as waning price pressures prompted traders to bet the BOE will increase borrowing costs later in 2015 rather than sooner.

More than four years after Osborne took office pledging to all but erase a record budget deficit by 2015, Britain is still on course to borrow about 100 billion pounds in the current fiscal year, or almost 6 percent of gross domestic product.

According to EY Item Club, austerity is set to continue for another four years, with Osborne now on course to achieve his goal of returning the budget to surplus in 2019-20, a year later than the OBR forecast in March.

“The improvement in the public finances is in danger of not just stalling, but going into reverse,” said Martin Beck, senior economic adviser at the forecasting group.

‘Structural’ Deficit

Record employment and the fastest-growing economy in the Group of Seven have failed to deliver the boost to government revenue the OBR predicted, partly because many of the jobs being created pay too little to be taxed. It also reflects weak wage growth and increases in the amount people can earn before they pay income tax.

“The higher U.K. deficit looks increasingly structural given its persistence, despite higher growth,” said Shahid Ladha, a rates strategist at BNP Paribas SA in London. “Future increases in public sector net borrowing could be larger and more painful.”

In the survey of gilt issuance in the current fiscal year, the highest estimate was 135 billion pounds at HSBC Holdings Plc. Toronto-Dominion Bank posted the lowest forecast, at 125.7 billion pounds.

Societe Generale SA, which sees the DMO leaving its plans unchanged, said in a note today it expects 10-year gilts to underperform 30-year notes as concern over borrowing grows. The yield spread between the two has risen by 14 basis points to almost 77 this quarter.

Gilts handed investors almost 13 percent this year, compared with 6 percent for Treasuries and 9 percent for German bunds. Traders have pushed back bets on a quarter-point increase to beyond October, Sonia forward contracts show. As recently as the summer, a move in February was projected.

While gilts may be underpinned by a shortage of top-quality government bonds, they may face pressure from a worsening fiscal outlook, said Ladha.

“This week is not the week to be long gilts versus bunds or Treasuries,” he said.

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