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The UK Treasury made a smaller than expected reduction to its target for bond sales this year as chancellor Jeremy Hunt put a £20bn tax cut at the heart of his Autumn Statement, halting a recent rally in the gilt market.
The Debt Management Office announced it would cut gilt issuance by £500mn in the current fiscal year to £237.3bn, a much smaller reduction than £15bn expected by 13 banks polled by Reuters.
It also scheduled two more gilt auctions for medium and long-dated debt before the end of the year and one index-linked gilt auction in January, helping to push yields higher as investors prepared for a bigger volume of sales than they had anticipated.
“Long-dated yields have risen quite significantly post the statement,” said Craig Inches, a bond portfolio manager at Royal London Asset Management, noting that the additional auctions were “not the Christmas present the gilt market was expecting”.
Yields on 30-year gilts rose 0.1 percentage point on Wednesday to 4.6 per cent while benchmark 10-year yields rose 0.06 percentage points to 4.2 per cent. Earlier in the day, yields had touched a five-month low, reflecting a global bond rally over the past few weeks.
Still, the sell-off was a far cry from September last year when then-chancellor Kwasi Kwarteng announced £45bn of unfunded tax cuts, sparking turmoil in government bond markets.
“It’s not what the market was expecting but it’s not a disaster,” said James Lynch, a portfolio manager at Aegon Asset Management.
Hunt was under pressure to project fiscal credibility to markets while also delivering tax cuts ahead of an election next year. Official data on Tuesday showed that UK borrowing between April and October had been nearly £17bn less than the Office for Budget Responsibility had previously forecast, owing to higher than expected tax receipts, giving the government breathing space to reduce its borrowing plans and deliver tax cuts.
“Given the volatility surrounding the UK’s fiscal outlook in the past 18 months, the Autumn Statement was an appropriately sober affair,” said Michael Metcalfe, global head of macro strategy at State Street, adding that Hunt had “just” met his fiscal rules.
The DMO said it would need to issue on average about £240bn of debt per year for the next four years — roughly £20bn a year more than its previous forecast.
Inches said the figures leave bond investors wondering “who will buy this mountain of debt”.
He added that elevated long-term borrowing costs were likely to become an “overarching theme in what is likely to remain an economic landscape of geopolitical volatility and sticky inflation”.
Despite recent declines, annual inflation remains well above the Bank of England’s 2 per cent target at 4.6 per cent. Still, markets are betting that the central bank is done raising interest rates.
Swaps markets are now pricing two or three 0.25 percentage point interest rate cuts from the BoE next year from a current level of 5.25 per cent, with the first cut fully priced for August next year.
The BoE has been pushing back against market pricing for interest rate cuts in recent weeks, with governor Andrew Bailey on Tuesday warning that investors had been putting “too much weight” on recent data which showed a sharp fall in headline inflation in October.
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