LONDON: Long-dated gilt yields rocketed on Wednesday after British finance minister Philip Hammond ramped up his forecasts for government borrowing in Britain's first budget update to count the cost of voting to leave the European Union.
Britain will need to borrow 122 billion pounds ($151 billion) more over the next five years than it expected before June's Brexit vote, Hammond said.
To cope with the higher borrowing, the UK Debt Management Office announced the biggest mid-year increase in government debt issuance since the financial crisis, bumping up gilt issuance plans by 15 billion pounds.
This was far more than primary dealers polled by Reuters ahead of Hammond's statement had expected.
Gilt prices, already pressured by strong US economic data, fell further when Hammond announced the increases in future government borrowing and again when the DMO set out its new issuance plans.
The 20-year gilt yield peaked at 2.037 percent, its highest level since June 23, the day of the Brexit vote. It last stood at 2.00 percent, up 9 basis points on the day.
The yield curve steepened significantly, with the spread between two- and 10-year gilts rising above 131 basis points, the highest since around a year ago, as 10-year yields rose as much as 12 basis points on the day
"Gilts are weaker but so are US and European bonds and this is for the same reason - a common theme of higher fiscal spending," said David Tan, head of rates at JPMorgan Asset Management Global Asset Management.
"The more we get on the fiscal front, the more room there is for central banks to normalise interest rates."
DMO chief executive Robert Stheeman told Reuters in an interview on Wednesday that he expected the gilt market to reprice itself efficiently in response to the higher-than-expected issuance.
The poll of primary dealers suggested the DMO would increase its stock of short-term treasury bills rather than increase gilt issuance significantly, but the reverse turned out to be true.
Societe Generale strategist Jason Simpson said the DMO may have been tempted to issue more gilts because the Bank of England looks set to remain a keen buyer of British government bonds through to the end of the 2016/17 financial year.
Although the BoE's post-Brexit vote bond-buying stimulus winds down in January, it will still have to reinvest the proceeds from the more than 11 billion pounds it holds of the 1.75 percent gilt maturing on Jan. 22.
"With that demand on tap, I think the DMO regarded this as an opportunity to issue a few more gilts in a way that wouldn't put a big strain on the market," Simpson said.
Stheeman said the decision to fund higher borrowing needs primarily through gilt issuance followed the pattern set the last time borrowing jumped sharply in 2011, and that the DMO aimed to issue evenly across different maturities.
Simpson added that there were big downside risks to the gilt market as inflation could overshoot the OBR's forecasts, while disappointing economic growth could push up issuance further.
The 10-year gilt yield was the biggest riser across maturities on the day, up 11 basis points at 1.47 percent.
The yield spread between 10-year gilts and the equivalent German Bund jumped around 6 basis points from level before Hammond's statement, peaking at 119.9 basis points in late trading - its highest since the referendum.
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