INTERVIEW-UK reducing inflation-linked bond issuance due to potential risks - DMO chief

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LONDON, March 13 (Reuters) - Britain is reducing the amount of inflation-linked government debt it sells due to growing concerns about the potential long-term risk to taxpayers, the chief executive of the UK Debt Management Office said on Tuesday.

Britain is the world's most enthusiastic seller of index-linked gilts, which pay a return linked to inflation, with more than 400 billion pounds' worth outstanding - equal to 26 percent of the total for British government bonds.

For Italy, the next-heaviest issuer among the Group of Seven developed nations, index-linked debt makes up under 13 percent of issuance. In the United States and Germany it is less than 10 percent.

On Tuesday, after a half-yearly budget update by finance minister Philip Hammond, the DMO said it intended to lower index-linked gilts' share of total issuance in 2018/19 to 21.1 percent, down from 23.1 percent in the financial year that is about to end.

"We are sending a signal that this is something the government is looking at much more closely than it has in the past," DMO chief executive Robert Stheeman told Reuters.

Index-linked gilts, known as linkers, have been a cheap way for the government to raise finance in recent years. Domestic pension funds need to ensure they have safe assets to match long-term inflation-linked liabilities, and have accepted below-inflation returns on government debt to do so.

However, a future surge in inflation would push up the government's debt servicing costs.

"To me this is a classic debt management issue," Stheeman said. "Linkers are very cost-effective, but they also if we continue to issue them at the same pace as previously potentially pose some fiscal risks."

Retail price inflation, the measure used to index the gilts, hit a six-year high of 4.1 percent in December, largely due to higher import costs since the pound fell after the Brexit vote in June 2016.

Stheeman said this recent rise was not the driver for the government's change in thinking. The Office for Budget Responsibility and National Audit Office raised concerns about index-linked gilts last year.

The OBR is due to report on the issue again in July, and the finance ministry said on Tuesday it would give a further indication of its long-term thinking about linkers then.

Stheeman said the DMO was aware of the high level of demand for linkers and did not want to put the market under stress. "We have got to make sure we are not starving that sector," he said.

BENIGN CONDITIONS

Earlier on Tuesday, the DMO said it planned to issue 102.9 billion pounds of gilts this year, in line with a Reuters poll and the smallest amount since the global financial crisis as public sector net borrowing drops to its lowest since 2002.

Overall, Stheeman said market conditions were benign and there was no negative effect from Britain's departure from the European Union in March 2019, or from the EU's MiFid financial services directive.

Bank of England data earlier this month showed that foreign investors cut their holdings of British government debt in January by the most in nearly four years.

Stheeman said it was not possible to draw clear conclusions from data for only a short period, but the change possibly reflected a recovery in sterling in late 2017 and this year.

Foreign bond funds often try to keep fixed proportions of different countries' debt in dollar terms, so a stronger local currency can prompt them to lower holdings of that country's debt. (Reporting by David Milliken; editing by David Stamp)