THE Treasury could be forced to issue an additional £10 billion of debt to plug its growing funding gap, putting further strain on the troubled gilt markets.

A disappointing set of public finance figures yesterday prompted City analysts to revise up their forecasts for gilt issuance this year, with government borrowing now considerably ahead of Treasury forecasts. Gilt issuance in this financial year could now be as high as £57 billion, compared with the £47 billion forecast by the Government at the time of the Budget, analysts said.

This new debt would come at a time when there are already widespread concerns about a bubble in the gilt markets. Bond prices have dropped sharply in the past month in response to fears about overvaluation.

Since its trough in June, the yield on UK ten-year gilts — which moves in the opposite direction to gilt prices — has risen from 3.9 per cent to almost 4.4 per cent. Further increases in yield are all but inevitable if gilt issuance rises sharply, analysts said. This would hurt the army of private UK investors who hold gilts, as well as making it more expensive for the Government to borrow.

“Gilts are expensive compared with equities,” said Michael Saunders, of Citigroup. “In the past few years, there haven’t been many gilts around. Now, there is going to be lots and lots.”

Surging government spending and lacklustre growth in tax receipts means that the borrowing targets set in the Budget look likely to be exceeded.

The Treasury has three ways in which it could plug this funding gap — raising taxes, cutting spending or increasing debt issuance. Additional debt is the politically palatable option, analysts said, meaning that gilt issuance is likely to increase sharply in years ahead.

David Page, of Investec, said: “Gilt issuance will need to be stepped up. We would suggest that gross issuance could be as much as £57 billion rather than the £47.4 billion expected by the UK authorities.”

Mr Saunders, who estimated that the Treasury could be forced to issue about £8 billion of additional debt this financial year, said: “Gilt issuance is set to stay high, and extra issuance will probably need to be announced when the Treasury revises the fiscal data in the Pre-Budget Report late this year.”

In June, borrowing as measured by the public sector net cash requirement jumped to £10.1 billion. This was substantially above City forecasts and the highest June figure on record. The deterioration in public sector net borrowing (PSNB), the Government’s preferred public finance measure, was less marked. But the PSNB in June, at £4.8 billion, was more than double the figure for the same month last year.

The data suggested Gordon Brown’s full-year target for a PSNB of £27 billion was set to be exceeded. George Buckley, of Deutsche Bank, said: “Another month of similarly weak public finances in July would mean that the deterioration in the deficit assumed for the entire year by the Government will have occurred in just four months”. Central government spending was 11.7 per cent higher in June 2003 than in the same month last year, while receipts rose just 4.5 per cent. The discrepancy between tax and spending will make it harder for the Chancellor to meet his golden public finances rule over the current economic cycle: borrow only to invest.

Extra borrowing raises the spectre that the Government’s budget deficit could breach the 3 per cent of GDP limit set down by Europe’s Stability and Growth Pact. This could be a hurdle to euro entry.