View from City Road: Bad news for gilts

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Funding is a subject of 'peculiar fascination' to many City commentators, the Chancellor said. Perhaps because it is like one of those old-fashioned psychological tests where you stare at an ink blot and see what you want to. Optimists make it all come right and pessimists cannot see how he will raise the money.

The differences have widened since the Budget. One reason is the inclusion of sales to banks and building societies. This was widely predicted and discounted in the market. What was not expected was the decision to make it retrospective, so gilt sales to them in the financial year just ending ( pounds 5.5bn by the end of February) for the first time will count as funding.

To confuse matters still further, the Government said those sales would be taken into account over two to three years.

First, the optimistic view. The financial sector has already bought the gilts for cash, and so common sense says they should be logged as overfunding in the 1992/93 financial year. Using that arithmetic, some believe that the Government may end this month having sold or committed - through part-paid issues - as much as pounds 11bn more gilts than it needs to cover 1992/93 funding. This is a down-payment on next year. If you assume the Government will also intervene to buy perhaps pounds 5bn of sterling with the foreign exchange reserves the picture looks even brighter, because that too counts as funding. Net gilt issues will be under pounds 30bn and UK institutions may be called on to buy fewer gilts next year than this (about pounds 19bn net, after redemptions). Life will be easy.

Others believe the Treasury will start the new year in April with a tiny amount of overfunding from this year; will only use pounds 2bn of the bank and building society backlog; will refuse to run down the reserves and will need net gilt sales perhaps as high as pounds 45bn. Oh dear.

Both scenarios rely on pounds 5bn or more of purchases by banks and building societies. Yet with a few exceptions they are not currently buyers of gilts and may run down their holdings again. Coupled with the Chancellor's gloomy hints about the medium-term PSBR, this will be bad for gilts prices.