View from City Road: The burden of gilt

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The Independent Online
ONE overarching question looks set to hang over the UK gilt and equity markets alike for the foreseeable future.

At what price will the Government be able to sell enough gilt-edged stock to fund fully its swelling borrowing requirement, and what knock-on effect will this have on the equity market?

The Treasury conceded in November that low growth in nominal GDP would push up the public sector borrowing requirement from pounds 37bn this financial year to pounds 44bn next.

Ever since then, market analysts have agonised over the fact that if sufficient gilt- edged stock was sold to mop up the PSBR then, at the equivalent of pounds 1bn a week, it would more than absorb the likely inflow of funds into the coffers of the UK's big investing institutions this year.

On this analysis the gilt market ought to be nervous about an upward drift in long- term yields. Equity yields, at an average 4.5 per cent, are a little less than half long gilt yields, which is as low a ratio as they have been for the past 15 years excluding sterling's brief interlude inside the ERM.

Any upward pressure on equity yields - and downward pressure on prices - from rising gilt yields could be compounded by sales of shares by institutions to pay for gilts. Mature pension funds, hit by falling real dividends last year, may also be shedding equities to meet their liabilities.

It could get worse. A growing number of independent forecasters are pointing out that if UK nominal GDP growth stays subdued, the PSBR could continue rising to pounds 60bn or more in the next few years.

But wide-eyed despair at this prospect may not be appropriate. There is a good chance that both the UK personal sector and overseas investors will be useful buyers of gilts. As public finances have deteriorated, the personal sector's financial surplus has been rising sharply since 1991, and it was a strong buyer of gilts last year - almost pounds 4bn in the first half alone.

A growing current account deficit is the mirror of a rising financial surplus in overseas hands. With sterling apparently stable and undervalued against the franc and mark, foreign buyers could also provide much needed relief.

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