Gilt auction setback for Bank of England

The Bank of England received another setback in its auction programme as bidders put in aggressively low offers and the total volume of bids barely exceeded the pounds 3bn of gilts being sold. However, the gilts market later recovered on hopes of an early cut in interest rates, buoyed by weak industrial production figures.

The difference in the auction between the average yield and the highest yield accepted, the "tail", was the largest on record. The average accepted yield was 7.45 per cent, the highest 7.56 per cent, a "tail" of 11 basis points.

"The Bank had to mop up a lot of silly bids," said Nigel Richardson, head of bond research at Yamaichi International. The Bank put a brave face on the reverse, saying that the dispersal of bids was not surprising given the recent market rally.

A further indication of the difficulty faced by the Bank in the auction was that it received bids only one-tenth higher than the pounds 3bn being sold. At the last auction in October the "cover" of bids was almost double the value of the stock on offer.

Immediately after the auction result, gilt prices slumped and at one point market-makers were said to be facing losses of pounds 100m. However, hopes of rate cuts following further evidence of a weak economy, together with a surge in US treasuries, led the market into a sharp rally and the March long gilt future ended up three-quarters of a point on the day. The short sterling future, which indicates interest rate expectations, ended trading implying a cut in base rates of more than half a point by March.

The trigger for renewed hopes of early interest rate cuts came from the latest industrial production figures. These showed a monthly fall in October of almost 1 per cent, although almost all of that could be attributed to the effects of weather. Temperatures at a 30-year high for October depressed gas extraction and the output of electricity and gas utilities.

Manufacturing output edged up by 0.2 per cent, in line with market expectations. The Central Statistical Office said the underlying annual growth rate of manufacturing remained at half a per cent. Output fell in food, drink and tobacco, chemicals, and textiles and clothing, but rose in engineering and coke and nuclear fuels.

According to Simon Briscoe, UK economist at Nikko Europe, the figures were "a pretty sharp reminder of weakness in the economy and a nail in the coffin for the growth pause theory".

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