View from City Road: Lost lustre returns to the gilts market

All that sulking in the gilts market about the way the Government cut base rates the day before the last auction has been forgotten. Market makers lost a few million in January because they were caught unawares, but they more than made up for it yesterday. The biggest auction so far proved to be the most heavily subscribed for 14 months, which is excellent news for the Government just ahead of a financial year with a pounds 50bn borrowing requirement.

Lucky bidders surprised themselves. They were in profit immediately, as gilt prices firmed by more than a point afterwards. Bids of pounds 5.869bn chased pounds 3bn of gilts, making the auction 1.96 times subscribed. The difference (or 'tail') between the highest and lowest price accepted was negligible, a sure sign of enthusiasm. The Bank of England opportunistically cut the price of an old tap stock to clear pounds 150m worth and announced a new pounds 600m, 10 year stock.

The main story in the market was that foreign interest did the trick, particularly Americans switching out of French bonds. According to Warburg, overseas investors may have been buying 10 to 15 year stock from British institutions in the grey market before the formal auction, freeing cash for the home team to take up the longer-dated 20 year stock on offer. UK institutions may not have been heavy net purchasers at all.

The foreigners appear to have been attracted by the yield advantage of gilts over French 20 year bonds, which has doubled to a full percentage point in six weeks and was moving up again after the election.

But reliance on foreign interest so early in the year is faintly worrying, not least because of the sharp revision downwards in the official estimates of institutional cash flow. As Peter Warburton of Flemings points out, the CSO's figures no longer justify talk of pounds 40bn cash flows, and even pounds 30bn might be a cause of celebration. Pension fund cash flow is under pressure from contributions holidays, more pensioners due to job shedding, and low wage growth.

This is no doubt one reason why the Bank of England is trying to lure private investors into the gilts market with a new free booklet available through Post Offices. But new punters should avoid long gilts such as yesterday's, and start with index- linked.