Gilts slide as Darling's forecasts prompt doubt

Scepticism about growth could jeopardise gilt issues

Waning confidence in the Chancellor's Budget growth forecasts sent gilts sliding yesterday, with prices touching their lowest levels since the Bank of England unveiled its quantitative easing programme in early March.

The yield, which rises as the price of a bond falls, on the benchmark 10-year gilt climbed to 3.51 per cent last night, up from 3.31 per cent on Tuesday and the highest since the Bank announced it would begin buying gilts and corporate bonds to increase the money supply and boost the economy.

The rise in gilt yields will worry the Treasury, with Alistair Darling's Budget revealing plans to sell a record amount of government bonds in order to finance his borrowing requirements. Any suggestion from the markets that the Government may find it difficult to find buyers for £220bn of new gilts would come as a huge blow.

Bond dealers attributed the rising yields to a lack of confidence in Mr Darling's plans to rescue the UK from recession. They are particularly suspicious about his economic growth forecasts, which are much more optimistic than the latest projections from the independent International Monetary Fund. The doubts may crystallise into a lack of demand as new gilts are issued, threatening to derail the Chancellor's plans.

Richard McGuire, a fixed income strategist at RBC Capital Markets, said the key issue was "whether the Budget presents a credible road map toward fiscal sustainability".

He added: "We would argue it is lacking", pointing out that the Chancellor's forecast of 1.25 per cent GDP growth next year was at odds with the IMF's prediction of a 0.4 per cent decline. "Further out, the Government assumes a rebound to 3.5 per cent in 2011, a percentage point or so above the trend rate," Mr McGuire said. "While the unusual degree of uncertainty plaguing economic forecasters makes it hard to refute these projections, they are clearly at the optimistic end of the spectrum." The scope for "bouts of indigestion" as new gilts hit the market was high, he added.

Analysts led by Deutsche Bank chief UK economist, George Buckley, also highlighted the dangers for the Chancellor, warning that while the Bank of England's bond buying programme and demand for short-dated gilts from domestic banks "should balance the supply and demand dynamics for short and medium gilt securities", "long-end supply could struggle to find buyers".

The concerns, which follow a failed gilt auction last month, were apparent in the movement of UK credit default swaps, which are used to insure against debt defaults. The cost of buying insurance against a default on £10m of gilts jumped from around £94,000 on Tuesday to around £98,000 on Wednesday.

Colin Harte, an investment manager at Baring Asset Management, added that even though he was "sanguine" about the Chancellor's forecasts, he remained cautious about the outlook for gilts. "A bigger risk for gilt investors will come later this year when the Bank will have to decide when to withdraw monetary accommodation," Mr Harte said. "We believe gilts remain vulnerable to a further-sell off in the market."