It may be the moment that the bull market in government bonds came to an abrupt end.
Although the gilts market was supported by the announcement of lower than expected government bond sales for 2012/13, traders warned a confluence of good news may bring to an end a rally that has seen longer-term borrowing costs fall to the lowest levels in more than 300 years.
Government bonds typically underperform when the economic outlook improves because this sparks a greater prospect of higher inflation that undermines the value of these fixed interest paying securities.
Benchmark 10-year gilt yields, which have an inverse relationship with prices, have risen nearly half a percentage point in the past week amid rising hopes over the health of the global economy and receding fears over the eurozone.
One senior trader at a European bank said: “The gilts market has come a long way. We have seen yields fall to very low levels. They may now be on the way up, particularly if quantitative easing [the buying of gilts to stimulate the economy] comes to an end.”
Other traders warn that the global outlook could easily turn sour, which could push yields back down to the record lows seen in January. They fell to lows of 1.91 per cent for 10-year bonds on January 18, the lowest levels for benchmark debt since the Bank of England first gathered data in 1703.
Yesterday the recent trend of rising yields was broken after the government announced gilt sales will be £167.7bn in 2012/13, lower than the market forecast of £180bn. The sale of pension assets held by the Royal Mail helped depress the amount of gilts the government needs to sell.
Government 10-year yields fell to 2.36 per cent.
Elsewhere, sterling remained steady against both the dollar and the euro and UK equities largely ignored the Budget statement. Traders said there were few surprises to trigger a reaction in the currency or equity markets.
The biggest movers among equities were in the housebuilding sector after the chancellor said the Get Britain Building fund would be expanded, with banks offering loan guarantees totalling £20bn.
Technology companies were also highly sought after the chancellor unveiled incentives for British media and technology groups producing films and electronic games.
The upgraded growth forecasts also hardened some views in the gilts market that QE will come to an end when the Bank of England’s current round of buying finishes in April. It will have bought £325bn in gilts by then. Although it did not impact on gilts yesterday, it could weaken the market in the future.
Another potential worry for gilts is the high level of issuance over the next five years with about £170bn in debt sales in 2013/14, £147bn in 2014/15, £123bn in 2015/16 and £106bn in 2016/17. If yields continue to rise, this could put pressure on government finances.
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