(Bloomberg) -- The UK is forecast to skew bond sales toward shorter maturities in the coming fiscal year to ease investor concerns over dwindling demand for long-dated debt in what could be another record year of supply. 

The Debt Management Office is expected to announce a target of £258 billion ($328 billion) in gilt sales for the year starting in April, up from £237 billion in the previous period, according to the median estimate of 14 primary dealers surveyed by Bloomberg. The share of long-dated bonds is forecast to fall to 19% from 22% in March last year.

The funding package carries extra importance for the market given sales from the Bank of England are also in full swing. If the central bank maintains its yearly target of reducing its gilt stockpile by £100 billion, the total stock of debt the market would have to digest this year would climb to an all-time high, according to banks including RBC Capital Markets and Citigroup Inc.

“The takeaway for markets is that we are still in a period of sustained and substantial gilt issuance,” said Imogen Bachra, head of non-dollar rates strategy at NatWest Markets. “We expect the market reaction to be driven by the extent to which the DMO skews issuance toward the shorter maturity buckets.” 

A supply shock risks exacerbating what has been a rough start to the year for gilts, especially if the extra stock of debt is accompanied by big pre-election giveaways that could fuel inflation. Prime Minister Rishi Sunak’s administration is seeking to close a significant gap in polls versus the opposition Labour Party ahead of a general election expected later this year.

The Times reported on Tuesday that Chancellor Jeremy Hunt will cut national insurance by two percentage points in Wednesday’s budget. UK bonds gained in response, leading an advance across major markets, with strategists saying a decrease would reduce the probability of tax cuts. The yield on 10-year gilts fell as much as 11 basis points to 4%.

But investors remain concerned about other risks, including dwindling demand from liability-driven investors such as pension funds, which have typically sought long and inflation-linked debt. 

Market participants in an annual Treasury meeting showed “strong support” for a proportional reduction in long bonds, with the “majority of investors” also preferring a smaller bucket of inflation-linked debt. A shift toward shorter maturities has also been signaled by outgoing Chief Executive Robert Stheeman.

Banks surveyed by Bloomberg displayed a wide range of responses for the gross DMO remit, with Barclays Plc forecasting around £226 billion and BNP Paribas SA seeing £272 billion. That speaks to uncertainty around Office for Budget Responsibility forecasts, which determine how much headroom Hunt has to play with under the government’s fiscal rules.

There was also divergence on the extent to which the UK will lean on alternative sources of funding, such as retail savings products and Treasury bills. 

The funding target for National Savings and Investments is expected to rise to £9 billion from £7.5 billion last year, though HSBC Holdings Plc sees an increase to £22.5 billion. On bills, the median forecast is for an increase in contribution to £10 billion, while linker issuance is seen at 10%, down from 12% in March.

The UK pension industry’s demand for long-dated debt is “not as vociferous and strong as it used to be,” said Miles Tym, a fund manager at M&G Investments, who expects a three-percentage point drop in the share of long-maturity bonds.  “If they don’t tweak it at all, I think you’ll find that the market will become a little concerned that long-dated supply isn’t being wound down.”

--With assistance from Naomi Tajitsu.

(Adds a Times report on national insurance and market pricing in the sixth paragraph.)

©2024 Bloomberg L.P.