Gilts lag Bunds on worries over UK inflation, deficit

LONDON: British government bonds drifted lower on Friday, underperforming German debt as concerns over the Bank of England's tolerance of high inflation resurfaced.

At 1100 GMT, the March gilt future was 29 ticks lower at 115.79, while the equivalent Bund future was 8 ticks lower.

Bunds fell after a better-than-expected German Ifo survey.

Minutes of the BoE's latest meeting showed that Governor Mervyn King and two other members of the Monetary Policy Committee wanted to relaunch bond-buying earlier this month, despite the central bank's forecasts suggesting that inflation will exceed its 2 percent target until 2016.

"The MPC minutes reinforced the message that policy will be kept accommodative, despite growing inflation risks. The medium-term risks facing gilts are increasingly bearish," Citi strategists wrote in a note.

The BoE has a good case for restarting monetary stimulus, and may need to buy up to 175 billion pounds ($267 billion) more of government bonds if growth is far below potential, rate-setter David Miles said late on Thursday.

That amount of additional gilt purchases would mean the central bank owned half of the conventional gilt market, said Monument Securities strategist Marc Ostwald.

"If that is not debt monetisation, then nothing is," he said.

Moreover, economists are divided on whether Britain will manage to meet his 2012/13 deficit-reduction goal.

Data on Thursday showed some improvement in public finances in January, but possibly not enough to make up for heavy borrowing earlier in the tax year.

Official statisticians also said that interest income from the central bank that can be used to reduce the fiscal deficit would be smaller than forecast.

And the independent Office for Budget Responsibility said that, regardless of the BoE contribution to government finances, tax revenue would need to rise much faster, or public spending would have to fall, if the government is to meet its 2012/13 borrowing target.

Ten-year gilt yields rose almost 4 basis points to 2.137 percent, with their spread versus equivalent Bund yields 2 basis points wider at 54 basis points.