LONDON, May 6 (Reuters) - Concern over Britain's fiscal prospects has made the outlook for government bonds, or gilts, less favourable, leading Franklin Templeton to exit long positions in the asset, its head of European fixed income, David Zahn, said on Tuesday.

With finance minister Rachel Reeves' budget plans hinging on a tiny buffer against the government's self-imposed fiscal rules - equivalent to less than 1% of annual spending - public sector finance data is in focus for markets.

Britain's government borrowed almost 15 billion pounds($20.06 billion) more in the financial year that just ended than official budget forecasters had estimated a month ago.

"In our European accounts, where we've been long gilts versus Europe since last year, we've sold them all," Zahn told Reuters, saying the UK's fiscal headroom had gone.

"They (the government) need to spend a lot more on the military. Tax receipts are not doing well, borrowing is going up."

Investment manager Franklin Templeton manages roughly $1.53 trillion worth of assets.

Zahn said that he anticipated higher government bond yields in the euro area given expectations for more fiscal stimulus and more bond sales, especially from Germany's new government.

He said the bloc's bond markets were probably "fully valued" at the moment and expected yield curves to steepen.

German conservative leader Friedrich Merz failed to secure enough parliamentary votes to become chancellor in a first vote on Tuesday, a major blow that threw politics in Europe's largest economy into disarray once again.

Zahn said he still expected German economic policy plans to remain on track.

EURO TO STRENGTHEN

Turning to currencies, Zahn said he expected the euro to benefit from broad dollar weakness and could rise to $1.25 by year-end.

The single currency, trading at around $1.1326 EUR=EBS, has gained around 9% so far this year.

The investment manager has added to positions in the Polish zloty EURPLN= and Swedish crown SEK= in recent weeks, partly due to attractive valuations after April's market turmoil, Zahn said.

Poland and Sweden should also benefit from stronger economic growth dynamics in Europe, he added.

"Currencies have become more interesting because volatility has increased," Zahn said.

($1 = 0.7477 pounds)

(Reporting by Dhara Ranasinghe; Editing by Rachna Uppal)

((Dhara.Ranasinghe@thomsonreuters.com; +442075422684;))