By David Milliken
LONDON (Reuters) - British government bond prices were on course for their biggest two-day fall since the 1998 emerging-markets crisis on Thursday as investors braced for a surge in public borrowing to cope with the damage the coronavirus is doing to the economy.
British gilts are normally viewed by investors as a safe haven at times of turmoil, but investors have dumped assets in their rush for U.S. dollars as the scale of the virus's impact on the global economy has grown.
Sterling fell to a 35-year low against the dollar on Wednesday and was roughly flat at 1300 GMT on Thursday.
"The general idea is that the UK will have to borrow even more - and with sterling being as weak as it is, where is the attraction?," said Marc Ostwald, global market strategist at ADM Investor Services.
Finance minister Rishi Sunak promised 330 billion pounds of loan guarantees and 20 billion pounds of direct extra aid for businesses on Tuesday, on top of higher spending he announced a week earlier.
Sunak has said he is studying ways of keeping people in jobs, and Ostwald said he expected the government would have to ramp up its spending plans again soon.
Ten-year gilt yields (GB10YT=RR) are up more than 40 basis points over the past two days - representing a price fall not seen since October 1998, according to Refinitiv data.
They peaked at 1.058% at 1138 GMT, their highest since May last year. At 1305 GMT, the yield was 16 basis points up on the day at 0.95%.
Illiquid markets were also amplifying price moves.
"The sell-off in gilts is not related to the macro fundamentals, but the lack of liquidity in markets," said Peter Chatwell, head of rates at Mizuho. "Market makers are not operating as usual, so all UK assets are at risk of illiquidity, which will a result in a weakness in prices."
Demand from investors remained solid at an auction of 3.25 billion pounds of five-year debt (GB5YT=RR), with bids totalling double the amount on offer - stronger than at an auction for the same bond two weeks ago, and only a bit below the long-run average.
However, similar to an auction of 30-year gilts on Tuesday, the DMO had to accept some bids that were well below the average price offered, in order to sell the full amount.
The Bank of England cut interest rates in an emergency move last week to 0.25% from 0.75%, and is likely to lower rates again next week after its next meeting, or possibly before.
It is also expected to restart its quantitative easing bond purchase programme.
The European Central Bank announced late on Wednesday that it would buy an extra 750 billion euros of euro zone debt over the coming year.
This supported German bond prices and - combined with the fall in gilt prices - pushed 10-year gilts' yield spread over Bunds at one point on Thursday to its widest since just before the 2016 Brexit referendum, at 129 basis points (DE10GB10=RR).
