Investors say a flood of gilt sales is pushing the cost of U.K. government borrowing, as markets are asked to absorb a record amount of bonds unless the Bank of England increases supply.
Over the past 18 months, bond yields have increased in most major economies due to rising inflation, resulting in numerous aggressive interest rate hikes and a price decline. But they remain stubbornly high in the U.K., despite going. It would help if you considered looking for other options. As of November of last year, the prices of gilt had already bounced back volatility caused by September’s disastrous “mini” budget, but yields have rebounded recently. Currently, the 10-year U.K. gilts benchmark yields 3.69%, while equivalent U.S. Treasuries yield 3.36%, and German bunds yield 2.19%. U.S. bonds have generally had high profits this year.
The change in value is an indication of the BoE’s predicted actions. To combat high inflation, they plan to increase interest rates by 0.5 percentage points this year. This differs from the U.S. Federal Reserve, which has already finished growing interest rates. Gilts have not been performing as well as German bonds, the standard for the Euro area where more rate increases are anticipated.
Many fund managers argue that the U.K.’s thick debt demand, driven by the BoE selling government bonds it bought under its quantitative easing programme, adds pressure on gilts. “Undoubtedly, the surge in gilt supply coupled with quantitative tightening is impacting prices,” said Matthew Amis, investment director at Aberdeen. The government intends to continue with its solid financial plans for the upcoming year. They plan to sell £241bn of gilts, a significant increase from the previous year’s £139.2bn. The issue net of BoE purchases is expected to be almost three times higher than the average over the past ten years.
Investors say the impact of government borrowing on the U.K. and other major bond markets is starting to show a widening “spread” – or difference in yields – an essential indicator that investors are demanding a premium for U.K. bonds. “The magnitude of the gilt supply is slowly dispersing with [German] bonds this year,” said Mike Riedel, bond fund manager at Allianz Global Investors. He buys government bonds because he expects the global recession to be far worse than market forecasts but prefers bonds in the U.S., Australia and Scandinavia over U.K. gilts.
“Everywhere there is a lot of net supply, but it is particularly pronounced in the U.K. People will buy at prices but not where we are today – not for long.” Economists at the credit rating agency Fitch forecast that combined debt sales from the U.K. government and BoE would equal 9% of GDP this year, and in the eurozone, the equivalent figure is just under 5 per cent.
There is also evidence of pricing pressure in U.K. bond auctions. According to Daniela Russell, head of U.K. rates strategy at HSBC, the gap between the average price paid and the lowest bid received has become more comprehensive than usual. The gilt market’s most significant buyer has already turned to a seller since the BoE started unloading its vast government debt portfolio last year.
Additionally, there are indications that foreign investors, who have typically been a significant source of demand, are now avoiding the market. BoE data released this week showed foreign investors were net sellers of gilts monthly this year, reversing net purchases of £36bn in the first quarter and £40bn in 2022.
“It’s a very marked selling pressure broadly similar to a trend we’re already seeing”. It’s part of this scarcity-on-claims story,” said Imogen Bachra, head of U.K. rates at NatWest. Investors pointed out that the scale of bond issuance is far from the only reason for rising yields – a double-digit inflation rate is hokey from the BoE’s meeting next week.
The message may have prompted many investors to gilt off too. According to portfolio manager Quentin Fitzsimmons from T Rowe Price, there are still concerns about borrowing despite recent weakness. Last year’s crisis brought about these concerns and was further fueled by the unfunded tax cut package proposed by former chancellor Kwasi Kwarteng. He said gilt yields would have to climb “significantly higher” than Treasuries to bring enough foreign investors back into the market.