By David Milliken
LONDON (Reuters) - Britain sold a government bond at auction on Wednesday that will pay investors an annual return of 5.668% - the highest yield of any gilt sold since 2007, as markets demand extra returns in anticipation of further Bank of England rate rises.
The United Kingdom Debt Management Office sold 4 billion pounds ($5.08 billion) of a government bond which will mature in October 2025, which attracted strong demand at 2.77 times the volume of offer, up from 2.34 times when the gilt was previously sold on June 7.
The last time the average yield at a gilt auction was higher was in June 2007, when 2.5 billion pounds of five-year gilts sold at an average yield of 5.790%.
Before that, the highest yield was in September 1999 when 2.7 billion pounds of 10-year gilts were sold at an average yield of 5.694%.
Less than two years ago - before the BoE had started to raise interest rates, and when inflation was near its 2% target - government bonds sold at auction with yields of less than 1%.
The auction highlights how the cost of British government borrowing has shot up this year. When the October 2025 gilt was sold at auction last month the yield was 4.874%, and at its launch in January it paid investors a yield of 3.634%.
Last month the BoE unexpectedly raised its main interest rate to 5% from 4.5%, as Governor Andrew Bailey said inflation looked more persistent than expected, and financial markets currently expect rates to peak at 6.25% in December.
Consumer price inflation held at 8.7% in May, and the BoE's most recent forecasts showed it dropping to just over 5% by the end of this year and below 2% by early 2025.
As a result, the real inflation-adjusted return for investors is likely to be far lower than when gilts last regularly had similar nominal yields in the late 1990s.
The October 2025 gilt is also unusual in paying a higher yield than other gilts of similar maturity. Bond strategists at NatWest last week described it as "one of the cheapest bonds on the UK fitted curve".
Yields on benchmark two-year gilts peaked at 5.406% on Monday, their highest since June 2008, and were 4 basis points lower on the day at 0945 GMT on Wednesday at 5.28%.
($1 = 0.7873 pounds)
(This story has been corrected to show yield highest since 2007, not 1999, in the headline and in paragraphs 1, 3 and 4)