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Commentary: Red flags as investors offload UK bonds at fastest rate in a year
October 31, 2017 / 1:51 PM / 24 days ago

Commentary: Red flags as investors offload UK bonds at fastest rate in a year

LONDON (Reuters) - Investors sold British government bonds at the fastest pace in a year just as interest rates look set to rise for the first time in more than a decade, a combination that could add billions to the country’s debt servicing costs in the next few years.

ETX Capital traders react as they watch the results for Britain's election in London, June 8, 2017. REUTERS/Clodagh Kilcoyne

Figures released by the Bank of England on Monday showed that domestic investors sold a net 23.7 billion pounds of government bonds, or gilts, in September, the most since they dumped 36.1 billion pounds of bonds in September last year.

It was the fourth biggest monthly divestment from British-based investors since the Bank started tracking these flows 35 years ago. Even after accounting for unusually high redemptions, September’s figures should be a warning to the government as uncertainty over the likely shape of Brexit persists.

Especially when it could mean an extra 11 billion pounds in debt refinancing costs over the next five years.

 

The selloff came just as a sudden hawkish shift from the BoE caught markets off-guard and forced a repricing of UK rate expectations.

On Sept. 14 the Bank said it was likely to raise rates in the “coming months” if the economy and price pressures continued to grow -- the clearest signal to date that Britain’s first rate hike since July 2007 is looming.

Rate expectations and gilt yields spiked. UK money markets now show that a quarter-percentage-point increase by the end of this year is seen as certain, with another, similar increase expected by the end of next year.

The magnitudes and levels may be small and low, but before Sept. 14 traders were betting the Bank would keep rates at their current record low 0.25 percent through at least the early part of 2019, when Britain is scheduled to leave the European Union.

Long- and short-dated gilt yields jumped, with two-year borrowing costs hitting 0.5 percent last week for the first time since the Brexit referendum in June 2016.

The question now is: will it be “one and done” from the Bank, or will the removal of its post-Brexit rate cut mark the start of a more prolonged inflation-fighting tightening cycle?

Either way, it will cost the government.

The cost of servicing existing debt doesn’t change. But other things being equal, a 100 basis point rise in bond yields will add 11 billion pounds over the next five years to interest payments on new debt, according to the Office for Budget Responsibility, whose forecasts are used by the government.

If gilt yields are 25 bps higher than where they were in March, that’s an extra 2.8 billion pounds in interest payments. A 50 bps rise will cost the government an extra 5.55 billion pounds.

These estimates are based on where gilt yields might be compared to March this year, the time of the OBR’s last set of forecasts. The two-year gilt yield today, at 0.45 percent, is 35 bps higher than it was then, while the 10-year yield is around 30 bps higher at 1.35 percent.

Of course, one month’s figures shouldn’t be taken in isolation as they may be distorted by unique external developments or subject to unusually extreme seasonal factors.

Monday’s figures showing the sharp fall in domestic holdings of UK government bonds may have been skewed by September’s 32 billion pounds of redemptions, the highest this year. Notably high redemptions were also seen in the last three months where net selling was heaviest: September 2016, March 2013 and March 2012.

 

But even accounting for quirks in the issuance calendar when maturing debt isn’t immediately matched by reinvestment into new bonds, September’s selling was still heavy. The government won’t want that to become a trend.

The opinions expressed here are those of the author, a columnist for Reuters. 

Reporting by Jamie McGeever; Editing by Catherine Evans

Our Standards:The Thomson Reuters Trust Principles.
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