Barclays Capital says that Darling’s over-optimistic economic forecast coupled with the assumption that debt/GDP ratios will continue to rise over the next four years means questions will remain over UK finances.
As a result, Barclays Capital says gilt yields will back up from their currently low levels due to the fact that the Bank of England must sell between £150bn and £200bn of gilts per year for the next three years to shore up Treasury finances. It says this may not be easy as more overseas investors begin to question the AAA status of the UK.
Analyst Simon Hayes says: “It seems likely that the market would have to readjust to having to absorb heavy supply and there is little to suggest that the necessary fiscal consolidation is in place. It will be a long, hard winter for the gilt market. We look for a continuation in the cheapening of asset swaps in the belly and an outright cheapening of the market.
“All told, we see little reason to change our fundamentally bearish view on gilt yields and on asset swaps in the belly of the curve.”
The Mortgage Practitioner principal Danny Lovey agrees with Barclays’ sentiment. He says: “Quantitative Easing has been holding back gravity for the last few months. In 2009, £200bn was pumped in and now, in 2010, £200bn has to come out and that means a steeper curve next year. Also the corporate bond market may follow, with spreads widening against gilts. It could be a double whammy for investors.”
Hayes says: “The report is likely to be seen as the first chapter of the story of the Treasury’s fiscal credibility that will only ultimately be resolved over the next year. The market may well have been promised a brighter future in the form of the Treasury’s optimistic medium-term view, but, as the Queen of Hearts said, “it’s jam every other day; today isn’t any other day”.”