The benchmark yields on 10-year gilts are likely to rise higher than their present level of nearly 4 per cent if the government’s quantitative easing programme grinds to a halt and the Bank of England stops buying up government debt in the coming weeks.

A week has passed since Andrew Sentance, an external member of the Bank’s monetary policy committee, provoked a sharp sell-off in gilts when he indicated that the Bank might pause its bond purchase programme, which had been part of its quantitative easing strategy.

With gilt issuance expected to be as much as £220bn a year over the next three years (compared with just £8bn in 1999), the fear is that supply will exceed demand at some stage.

But this prophecy has yet to come to pass and the UK’s government bond market still throws up a mixed picture.

At present, demand from devotees of the market such as pension funds and insurers, which are required to sell equities and buy gilts in stages to fund pensions, is healthy. But foreign central banks and sovereign wealth funds, which are also major bidders in gilt auctions sponsored by the Debt Management Office, have lost much enthusiasm.

The latest figures from the Bank show that overseas investors were net sellers of about £16bn-worth of gilts over the past four months.

Paul Grice, head of UK government bonds with F&C, said: “The government’s QE [quantitative easing] programme has been relatively successful, but it’s just about coming to an end as far as we know. And this creates a very uncertain picture.

“The bare facts suggest higher yields are coming, which is good for those who haven’t bought yet and bad for those who have.”

A plus, however, is that UK banks are stepping up their gilts purchases, with net buying of more than £30bn in the first three months of the year. This is part of their attempts to strengthen their balance sheets and also prepare for the new capital requirements ordered by the Financial Services Authority. As a result, the banking sector is expected to increase its gilt holdings by between £150bn and £200bn.

“Such a development would mean that the banks will be the biggest buyers of gilts for many years ahead,” wrote David Scammell, head of fixed income at Schroders, in a recent note.

If there are further rounds of gilt sell-offs and yields march upwards, then it is likely that corporate bonds – a stable investment for investors looking for income – will suffer knock-on effects.

Optimists say corporate bonds are likely to still do well in comparison as they are still rebounding from lows last hit during the peak of the credit crunch. Even so, an aggressive gilts sell-off could prompt a mass exodus from corporate bonds as well.

Adrian Lowcock, senior investment adviser with Bestinvest, expects corporate bond funds to benefit from gilt market disruption as funds could flow out of gilts and into riskier assets. “The relief that things might not be quite as bad may well support prices and see corporate bond yields coming down,” he says.

Scores of investors already regard corporate bonds as something of a safe haven. Since January, hundreds of thousands of pounds have moved into corporate bonds from savings accounts as investors seek higher returns than the 1 per cent offered by many high street banks.

While the bonds issued by pharmaceutical groups, utilities, telecom groups and food retailers looks expensive, other areas are more attractive, according to Stephen Snowden, who manages Old Mutual’s corporate bond fund.

“We believe that commodities, infrastructure, financials, pubs, property, tobacco and asset-backed securities offer exceptional value,” he says.

“Although these sectors carry more risk during a period of economic weakness, investors are well compensated for taking it on, particularly when compared with expensive alternatives in defensive sectors.”

Index-linked gilts, which offer protection against inflation, are another alternative – particularly as fears over rising prices grow. Apart from more expensive long-dated gilts, index-linked gilts look increasingly enticing as their supply is limited while demand is rising. And investors’ appetite for them has been helped by the better tone of recent economic data and receding concerns about deflation.