In last week’s Budget, Chancellor Philip Hammond announced the deficit is expected to fall from a peak of 88.8 per cent of economic output next year to 79.8 per cent in 2021/22, although fixed income commentators are split on how this could impact gilt sales in the next few years.
For 2016/17 the Debt Management Office has kept gilt sales at £146.5bn, although it has reduced the planned issuance of Treasury bills, providing £14.3bn in net cash for the DMO.
David Page, senior economist at Axa Investment Managers, says: “Most of this will be unwound in 2017/18, reducing gilt sales in that year,” he adds. “The DMO cash holding will be planned to reduce by £14.3bn and planned Treasury bill issuance will fall by £9.5bn, reducing gilts by £23.8bn. This suggests gilt sales of £115bn in 2017/18.”
While Page says gilt sales should remain at a similar level in 2018/19, he predicts they could rise to £125-130bn the following year due to a slowdown in the take-up of the National Savings product and rising gilt redemptions.
Seamus MacGorain, global rates portfolio manager at JP Morgan Asset Management, expects gilt issuance to continue to fall over the next few years on the back of further fiscal tightening and lower deficits.
“Gilts have performed very well this year with economic data weakening from a very strong level and the prospect of reduced issuance having provided a further tailwind. We anticipate gilt yields to rise by year-end, largely because of the US Federal Reserve’s shift to a more hawkish stance.
However in the near term, MacGorain says we are more likely to see quantitative easing than higher rates, which will temper rising yields.
“Gilts should be partly insulated from these global factors by slowing growth and a ‘steady as she goes’ stance from the Bank of England. We think monetary policy will remain on hold in the UK this year and that further easing is still more likely than tightening.”
If quantitative easing does not continue next year, net gilt sales could actually rise, says Mike Riddell, fixed income portfolio manager at Allianz Global Investors.
“People are focusing on the gross issuance numbers, but the important thing to look at from a gilt market perspective is actually the net issuance, where you have to bear in mind that in the fiscal year 2016/17 we have had the Bank of England buying a good chunk of what the DMO was selling,” he says.
“Net issuance in 2016/17 was actually the lowest since 2002/03 once you take into account QE asset purchases. If the Bank of England does not restart QE in 2017/18, then net issuance will actually rise next fiscal year.”
David Zahn, head of European fixed income, Franklin Templeton Fixed Income Group, says the Budget was “reasonably supportive of the gilt market”, with the decreasing deficit a boon for longer-term gilts.
“The key point to note is that over the next few years the UK will need £23.5bn less bonds than before, in simple terms this means there will not be as much supply as the market was expecting,” he says.
“However, it will be the very short end that will be under pressure as we won’t see much issuance here, especially in the T-bill market. The overall maturity profile will be lengthened into longer dated bonds. In general, the Budget shows that the Government is serious about getting the deficit down to a reasonable level, which is supportive of gilts longer term.”