U.K. Debt Chief Wary of Shocks After 20 Years of Falling Yields

Updated on
  • Gilt market faces BOE rate rises, geopolitical risks: Stheeman
  • Twin deficits, Brexit not good for British debt, SocGen says

It’s been 20 years since Britain’s debt issuing office was founded, when U.K. yields were 6 percent. Geopolitical risks and interest-rate rises are now the main risks to keeping the country’s borrowing costs low, according to its chief.

With one year to go until Britain leaves the European Union, Brexit effects have been “relatively muted” in comparison to the 2008 financial crisis, but the market is robust enough to deal with any potential shocks, said Robert Stheeman, the chief executive officer of the U.K.’s Debt Management Office.

The U.K. 10-year gilt yield has steadily fallen to less than 1.4 percent currently, driven by years of quantitative easing and a global bond rally this month. Stheeman’s comments came as the Bank of England mulls raising rates for the second time in six months, while elevated fears of a world trade war, especially between the U.S. and China, have roiled investors.

“It is in the nature of today’s world that unexpected events can prove disruptive also to smooth financial market functioning,” Stheeman said in an email interview. “Geopolitical event risks and, indeed, future tightening of monetary policy might impact the price at which our financing program is delivered.”

Liquid Gilts

Issuance surged during the financial crisis, boosting stock of bonds available

Source: DMO

While the U.K.’s twin fiscal and current-account deficits leave yields vulnerable to global investors losing appetite for British assets during Brexit, there’s plenty of demand for long-dated British debt to protect borrowing costs from blowing out, according to Kit Juckes, a strategist at Societe Generale SA. It could be at least another twenty years until the yield on U.K. government bonds reach levels of 6 percent again, he said.

“It’s going to take a lot of bad news, geopolitical or otherwise, to trigger some kind of gilt Armageddon,” said Juckes, who sees the 10-year yield at 1.85 percent by year-end. “But running a big current-account deficit and a big budget deficit at the same time as decoupling from a huge free trade block isn’t good.”

The supply of U.K. government bonds will fall to 102.9 billion pounds ($145 billion) in the fiscal year 2018/2019, the lowest level in more than a decade, as U.K. Prime Minister Theresa May’s Conservative government seeks to cut the budget deficit.

DMO Birth

The DMO was founded on April 1, 1998, when it took over gilt management from the BOE under a shake-up by the then-Chancellor of the Exchequer Gordon Brown. The financial crisis divided its twenty-year life, boosting issuance from just over 50 billion pounds in 2005/2006 to a record 228 billion pounds in 2010/2011.

Even so, demand for gilts, perceived as one of the safest assets in the world to own, remained strong and the surge in supply had the side effect of creating much needed liquidity in the market. At the same time, a low-inflation environment and an aging population has boosted demand for longer-dated debt, Juckes said.

Britain now has one of the longest debt profiles in the world, with the weighted-average maturity at 14 years, compared with nine in Germany and less than seven in the U.S., meaning it has to refinance expiring bonds less often. Still a large share of outstanding supply is made up of index-linked gilts, which are more exposed to inflation, something the DMO noted following its remit for the new financial year earlier this month.

“I don’t have a crystal ball,” Stheeman said. “The gilt market is deep and liquid and has a track record of successfully adjusting to a number of external shocks.”

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