The gilt market will see a massive rise in the effective supply of stock next year, which might depress shares as well as gilt prices, economists warn. "The market faces a six- or seven-fold increase in net supply in 2010-11" says Simon Ward at Henderson Global Investors.
The problem is not merely government borrowing. Indeed, the Treasury expects the central government net cash requirement - the main determinant of gilt issuance - to fall from £223.3bn in 2009-10 to £174bn in 2010-11, if only because the government isn't planning to buy any more bank shares.
Instead, the danger is that quantitative easing might end in February. And if the Bank of England stops buying gilts, the market will have to do step into the breach and do so. Mr Ward estimates that in this financial year, the Bank will buy £183bn of gilts, as the government issues a net £208.5bn. That leaves just a little more than £25bn for the market to absorb. But, if QE stops next year, the market will have to buy all of the £150bn of gilts the government is expected to issue.
Basic economics says that an increased supply should mean lower prices and so higher yields. This, warns Mr Ward, will increase the government's cost of borrowing and so intensify the pressure to tighten fiscal policy seriously.
It would also be bad for shares. If gilts offer higher expected returns courtesy of higher yields, then equities, which compete against gilts for investors' pounds, will have to offer higher returns too.
And these pounds will be more scarce. If investors have to buy an extra £125bn of gilts next year, that's £125bn less for them to put into the stock market - a sum equivalent to 7.5 per cent of the total value of the equity market.
But there is a possible saviour here - the global economy. The IMF forecasts that this will generate $13.7bn (£8.4bn) of new savings next year. Gilts need attract only 1.8 per cent of these - less than the UK's share of world GDP - to sell £150bn of stock. And because gilts are close substitutes for other government bonds, it's possible that even a small rise in yields might be sufficient to attract buyers.
This implies, though, that the gilt market will become more vulnerable to swings in international investors' sentiment. And as investors in many emerging markets will testify, such swings can be large and unpredictable.
