Investors flock to fat return on UK inflation-linked debt

LONDON, July 13 (Reuters) - Britain received a hefty 39.4 billion pounds ($51.6 billion) of orders from investors when it sold 3.5 billion pounds of inflation-linked bonds on Thursday, but faces paying one of the highest interest rates in years for this type of debt.

The March 2045 index-linked gilt will pay investors a return of 1.241% above the rate of inflation, the highest real yield of any index-linked gilt sold in syndications going back to 2005.

Looking at more frequent auctions, there was a higher yield for a 2051 index-linked gilt sold in October 2022, in the midst of bond market turmoil during former Prime Minister Liz Truss' premiership. The highest yield before that was in 2009.

The United Kingdom Debt Management Office said British investors accounted for 93% of purchases of the gilt, which is of a type attractive to pension funds and life insurers who have to hold assets which back their long-term liabilities.

The bond sold at a 4-basis-point premium to the 2044 index-linked gilt which acted as a benchmark, at the top end of initial price guidance as usual at gilt syndications.

DMO chief executive Robert Stheeman said the sale "was an indication of the ongoing demand from our core investor base for instruments which offer inflation protection".

The bond attracted a record 46.4 billion pounds of orders when it was

first sold

in April.

However, earlier on Thursday the British government's

Office for Budget Responsibility

highlighted how heavy past issuance of inflation-linked bonds - for which investors until recently accepted negative real returns - had left the country's finances highly exposed to rising inflation and interest rates.

Yield on short- and medium-dated British conventional gilts rose to a 15-year high last week as investors bet persistent inflation would force the Bank of England to raise interest rates to 6.25% by the end of the year, up from 5% now.

However, yields and rate expectations have fallen back since the release of weaker U.S. consumer price inflation and producer price data. Five-year gilt yields dropped to their lowest since June 29 on Thursday at 4.546%, down 40 basis points from last week's peak.

The DMO said that following Thursday's sale, it had raised 74.1 billion pounds of the 237.8 billion pounds it is seeking to raise in the 2023/24 financial year.

Barclays, Citi, Lloyds and NatWest Markets acted as lead managers on the transaction.

($1 = 0.7637 pounds) (Reporting by David Milliken; Editing by Andrew Heavens)