Rising bank demand to offset gilt issuance surge-study

LONDON Jan 28 (Reuters) - Rising demand for gilts on the part of banks could help offset a surge in government debt issuance, keeping debt servicing costs low by historical standards, a study showed on Wednesday.

Research by Morgan Stanley and the Institute for Fiscal Studies suggests new rules to boost banks' liquidity reserves could trigger more than 100 billon pounds of new demand for gilts next year.

Britain plans to issue 146 billion pounds of gilts this year -- a record level swollen by the government's recapitalisation of some of the country's major banks.

"It seems ironic that the banking system, whose travails are directly and indirectly responsible for much of the explosion in gilt issuance, should be a major buyer of extra government debt," the study noted.

"But owning gilts is likely to become more attractive for banks in the coming years."

Britain's Financial Services Authority recommended in December that banks be required to hold a greater proportion of highly liquid assets to make them less vulnerable to market shocks. Although not specified, gilts would be the natural candidate.

The FSA wants to introduce the new regime by October. It will apply to UK banks, building societies and many investment firms.

Morgan Stanley analyst Laurence Mutkin said overseas investors would probably own a smaller share of the gilts market in the coming years. But he said this would be offset by a strong rise in demand from banks, which have owned almost no gilts for the past 10 years.

Gilt demand, he said, was also likely to increase from households looking to rebuild savings and pension funds looking to take advantage of higher long-term yields. "Demand for gilts looks like it will rise to meet the additional supply, if not surpass it," said Morgan Stanley analyst Laurence Mutkin.