Interest rate and gilt supply projections
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This Wednesday, 19th March is a key date for UK markets, with the minutes of the last Bank of England Monetary Policy Committee (MPC), the latest unemployment data and Chancellor Osborne’s Budget speech.
The MPC has shown unusual unanimity of late, and the minutes should contain only marginal new insights and no surprises. In contrast, the unemployment number is capable of surprising in either direction, as seen with last month’s uptick to 7.2%, and the Budget always has the possibility of shocking.
Importantly, the premise that there is increasing evidence of sustainable momentum behind the UK’s economic recovery would support the Office for Budget Responsibility (OBR) revising its net borrowing requirement projection down from the Autumn Statement made on 5th December. In the table below we reproduce these figures, and the implications for gilt supply assuming a similar-scale T-bill financing buffer as originally planned for 2013-2014. For comparison, the 2013-2014 gross gilt supply target is a very similar £160bn. We also expect a very similar mix of maturities and linkers to the current year’s supply, which has been very well-received.
| Table: OBR gross financing projections with CCLA bill estimate | |||||
| £ billion | 2014/15 | 2015/16 | 2016/17 | 2017/18 | 2018/19 |
| CGNCR exc. B&B and NRAM projections | 99 | 84 | 71 | 43 | 9 |
| Gilt redemptions | 62 | 70 | 69 | 79 | 67 |
| Financing for the Official Reserves | 6 | 0 | 0 | 0 | 0 |
| Illustrative gross financing requirement | 167 | 154 | 140 | 122 | 76 |
| CCLA net bill financing estimate | 10 | 9 | 8 | 7 | 5 |
| CCLA gross gilt supply estimate | 157 | 145 | 132 | 115 | 71 |
| Source: DMO and CCLA | |||||
The risks to our £157bn estimate for next year are biased to the downside, but we expect the Treasury initially to be conservative about its proceeds from the recovery. If and when these funding requirements are undershot as the year evolves, we would expect the government more likely to increase spending rather than reduce borrowing with an eye on the general election in 2015. The government’s next step would be to reduce financing from bills as in 2013-2014, when the initial net £10bn target was cut to zero after the Autumn Statement. These options give the government plenty of room for keeping the gilt issuance plans stable once announced.
In the long term, the improving prospects for growth and the fiscal deficit support wider gilt spreads, and the dramatic flattening in 10s/30s that occurred once recovery became evident leaves spreads roughly in line with historical relationships with swap spreads and the deficit.
We set out our current projections for the Official Rate and gilt yields for periods ahead in the table below.
| UK – Gilts | Current | End Q1 2014 | End Q2 2014 | End Q3 2014 | EndQ4 2014 |
| Official Rate % | 0.50 | 0.50 | 0.50 | 0.50 | 0.50 |
| 2 year yield % | 0.48 | 0.60 | 0.70 | 0.80 | 0.90 |
| 5 year yield % | 1.66 | 1.70 | 1.80 | 2.00 | 2.20 |
| 10 year yield % | 2.80 | 2.90 | 2.95 | 3.05 | 3.15 |
| 30 year yield % | 3.55 | 3.60 | 3.70 | 3.80 | 3.90 |
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
