LONDON (Reuters) - Britain drew the strongest demand for its government debt in more than a year and a half on Thursday as investors rushed to snap up 20-year inflation-linked bonds following Chancellor Philip Hammond's first annual budget.
British public borrowing in the financial year ending this month is set to come in below forecasts, prompting the UK Debt Management Office to sharply lower issuance plans for 2017/18 compared with the current financial year.
Much of this was already priced into the gilt market in the run-up to the budget, when it had outperformed other markets, but there was further outperformance on Thursday which pushed the 10-year U.S. Treasuries spread over equivalent gilts to its biggest in over 20 years at 1.37 percent.
The U.S. Federal Reserve is expected to raise interest rates next week for the third time since the financial crisis while the Bank of England is not expected to increase borrowing costs until 2019 at the earliest.
Demand for the 725 million pounds of 0.125 percent 2036 index-linked paper on sale was the strongest for any gilt auction since June 2015, with investors bidding for 2.95 times the face value of the gilts on offer.
Gilt futures FLGcv1 rallied after the auction, gaining more than 20 ticks, and 10-year gilt yields stood 1 basis point down on the day at 1.21 percent at 1230 GMT as yields backed further away from a two-week high struck briefly on Wednesday after the DMO lowered issuance slightly less than expected.
DMO chief executive Robert Stheeman told Reuters that the agency wanted to avoid going "from feast to famine" with the amount of gilts it sells.
Jack Di Lizia, a fixed income strategist at Deutsche Bank, said one factor could be the relatively long wait - potentially as long as July - before the DMO sells a significant volume of index-linked gilts via syndication.
"There has been a strong bid for inflation-linked gilts following the budget. If you look at the auction, it was well covered," he said.
"Linkers that tend to be syndicated are longer-dated than those at the auction, so it's difficult to read too much into the two, but all things being equal ... a longer pause would tend to be supportive of linkers."
But he saw little scope for further overall gilt outperformance driven by supply factors - especially as Bank of England's gilt buy-backs are due to finish next week.
($1 = 0.8222 pounds)
Reporting by David Milliken; editing by John Stonestreet