Demand falters for government bonds after ‘shock and awe’ budget

A post-budget auction of UK bonds has faltered amid the weakest demand for government debt in almost a year — a sign of lingering investor anxiety over the £28 billion increase in government borrowing announced in last week’s budget.
Investor appetite was sluggish despite the average yield on offer for the newly issued 10-year bond climbing to 4.475 per cent from 4.17 per cent on the previously issued one. A higher yield should attract more investors.
The Debt Management Office, which oversees the Treasury’s borrowing needs, said the total value of bids placed by investors to buy the new 10-year government bond was enough to cover the £3.75 billion on offer 2.81 times over, the lowest ratio since last December.
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A reduction in the bid-to-cover ratio indicates that demand has waned. The last bid-to-cover ratio for a new 10-year bond was 3.25.
Concerns about the outcome of the US election may also be a factor in the lacklustre demand.
“Market focus is now squarely on the US election, given the close race and potential market ramifications,” said Neil Mehta, portfolio manager at RBC BlueBay Asset Management. “Gilts are now taking a back seat.”
UK government bonds, also known as gilts, are IOUs issued by the government when it needs to borrow money. They are usually issued for a fixed term, from a few months to 50 years. Investors get an annual interest payment, and when the bond matures they get their money back. The rate of interest they are prepared to accept depends on their confidence in the long-term health of the government and the economy.
UK bonds were sold off sharply last week after the chancellor Rachel Reeves announced plans to increase borrowing and boost investment, fuelling concern about inflation and fiscal pressures. The sell-off reduced bond prices and pushed up bond yields, which move inversely to prices. Moody’s Ratings described the budget as Britain’s most aggressive fiscal loosening since the pandemic and said it posed new challenges to the public finances.
The chancellor announced a sharp increase in borrowing of £28 billion at last week’s budget to mainly fund a rise in public investment spending, higher than analysts had anticipated. Government bond sales will rise to £300 billion as a result of the budget measures.
In response, investors sold UK government bonds, pushing up yields by about 25 basis points in the 48 hours after the budget. It was one of the biggest jumps ever in UK government borrowing costs following a fiscal event, excluding Liz Truss’s mini-budget in September 2022.
Analysts at UBS, a Swiss investment bank, said that the supply of UK government debt was “at historically normal levels” when accounting for the size of the country’s savings and GDP. However, “what ails gilts is their demand side. Pensions demand has been lost and must be replaced. Gilts must deepen foreign demand and bring back the banks.”
Greater government spending over the short term was judged by the Office for Budget Responsibility (OBR) to be likely to push up inflation, leading to fewer interest rate cuts by the Bank of England, putting further upward pressure on gilt yields. OBR economists also said that annual government debt interest spending would top £100 billion every year until 2029-30.
The central bank is expected to lower borrowing costs by 25 basis points at its meeting on Thursday, taking the base rate down to 4.75 per cent from 5 per cent.
Analysts at Citibank, the US investment bank, said: “The fiscal loosening makes it harder for the Bank of England to accelerate cuts and keep up with the pace of easing elsewhere. Gilts should find tentative stability around current valuations, however, as has been evident since Friday.”
However, analysts at Blackrock, the investment firm, said that a “tepid UK growth outlook” would force the Bank to loosen policy more than markets expect, putting upward pressure on gilt prices.
On Tuesday yields on UK government bonds traded in financial markets were broadly stable. The pound strengthened 0.24 per cent against the dollar to $1.298, and was up 0.07 per cent against the euro at €1.191.