The imbalance between demand and supply in the gilt market continues to create an inverted yield cur...
The imbalance between demand and supply in the gilt market continues to create an inverted yield curve, with little sign that increased issuance will alter the situation.
In the 30-year area of the curve, gilts are yielding around 4.3% with 10-year gilts on a yield of 5.15%. Institutional demand continues to be strong at the long end of the market, with many life insurers buying long-dated gilts to get the necessary asset liability matching in pension funds. With Government finances heading for another surplus in the financial year, there appears to be little need for more gilt issuance.
The rise in UK interest rates earlier this month provides further support to the gilt market. Rates rose by a quarter of a point to 5.5%. The rise is being taken as a sign that the Bank of England's Monetary Policy Committee (MPC) is particularly concerned about the booming property market and is looking to keep a firm lid on any inflationary pressures.
In its quarterly inflation report published last week, the Bank of England said that it expects the UK economy to pick up speed in the coming years while still anticipating that inflation will remain low.
The Bank of England expects UK GDP to expand at an annual rate of between 2.5% and 3% over the next two years, led by rising consumer spending and business investment and rec-overy overseas. But members of the MPC are split on the consequences for inflation. A majority saw the rate of increase of retail prices falling to just below 2% in 2000 and then rising to the bank's 2.5% target rate by 2001.
Peter Price, head of fixed interest at Hill Samuel Asset Management, says: "Firstly, we, like everyone else, were unsurprised by the recent rise in UK interest rates, but what this means for interest rate policy going forward is a difficult one to call.
"We believe interest rates should rise by a lot less than the market is expecting.
"It is possible interest rates may rise to 6% even though our view is that they probably do not need to. We are in the camp that says growth can be higher than it has been in the past without inflation going up. We are strong in the view that factors such as competition can keep shop prices down.
"If interest rates are put up further there is a serious risk that we could see rates going down again this time next year. We are not in the inflation camp."
Alan Wilde, head of fixed interest at Scottish Mutual, is long of benchmark on gilts and is tending to own stock at the short and long end of the market. Two-year gilts are currently yielding just over 6% while five-year gilts are on yields of 5.80%. Wilde is forecasting that the yields on 10-year gilts will drift out towards 5.20% to 5.25% by the year end.
Wilde agrees with Price that the MPC did not surprise the bond markets by raising interest rates, but adds: "I think that we have probably seen the last of the interest rate rises until February. I think that the MPC will probably want to wait for the data from December and January, particularly on wage settlements."
Price adds that there is still a shortage of stock at the long end of the gilt market and adds that the Government could be looking at a surplus of more than £3bn. Price says Hill Samuel is long of its benchmark on gilts as he is fairly bullish on the prospects for bond markets going forward. He is tending to invest more in the 20-year area of the curve, which is yielding around 4.6%. He is also favourable towards areas of the market of less than 10 years duration, with, for example, nine-year gilts yielding around 5.5.5%.
‘Important to have an anchor’
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