LIVE MARKETS-Stay long gilts, say UBS

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STAY LONG GILTS SAY UBS

British markets, especially government bonds, or gilts, provided plenty of drama for markets last week. UBS strategists have a note out on Monday recommending investors stay positive on the asset class.

Wednesday's tearful appearance by Chancellor Rachel Reeves in parliament a day after the government backed down on its welfare reforms reignited concern over Britain's finances, and caused a steep selloff in gilts. Ten-year yields rose more than 20 basis points at one point. GB10YT=RR

"Inflation dynamics and the direction of travel on borrowing, particularly in the near term, matter more than the political concerns," UBS say.

They see British inflation slowing, making it easier for the BoE to cut rates - positive news for gilts - and note that in the short term, borrowing is little changed as a result of the U-turns.

Things are more worrying for longer-term borrowing, but UBS see pressure on Britain's fiscal position resolving in three ways, only the least likely of which is bad for gilts.

- the government might be lucky and lower interest rates could restore a good chunk of its lost headroom. Bear in mind current government forecasts are project 10-year gilt yields to rise to 5.2% by 2029 a roughly 70 bp increase from current levels.

"In the right circumstances, lower rates could drive a virtuous circle for rates by contributing to confidence in public finances," they write.

- more borrowing, bad for gilts, but that would require the government to change its fiscal rules, something the market has made clear it won't accept.

- higher taxes, this is UBS's expectation and are also seen in media reports. This is potentially good for gilts, as it means no extra borrowing, and also UBS say: "fiscal drag should make the path to lower front end rates easier," and "lower front end rates and adherence to the fiscal rules would then support long-term rates."

(Alun John)

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