UK inflation debt sale attracts robust demand

A sale of UK index-linked bonds attracted more than £10bn in orders on Tuesday, in a fresh sign of demand for securities that offer some protection against rising consumer prices after years of subdued inflation.

It comes as investors assess competing forces affecting the UK economy following a vote to leave the EU in June. Expectations of economic growth fading at the same time that a slumping pound pushes up import prices, is seen complicating the Bank of England’s policy options in 2017.

The Debt Management Office issued a £2.25bn 40-year bond maturing in November 2056 at a yield of minus 1.466 per cent, two basis points below the yield of an existing bond due to mature in 2058.

So-called “linker” bonds pay a coupon determined by the prevailing rate of retail price inflation in the UK. That provides investors with a form of protection against inflation which erodes the value of fixed coupons paid on standard government bonds.

John Wraith, head of UK rates strategy for UBS, said Tuesday’s sale indicated substantial investor interest in such securities. “In round numbers most people are assuming over the next six months to two years inflation will rise to 2.5 to 3 per cent then stay there for some period of time,” he said.

Market prices also highlight a challenge facing the central bank, to support the UK economy through any disruption associated with Brexit negotiations while also targeting inflation of 2 per cent. The implied rate of annual retail price inflation for five years, in five years’ time, is around 3.5 per cent: “It’s probably on the high side,” said Mr Wraith.

Demand for such linkers has recently outstripped orders for conventional debt, with a September sale of £400m of such paper maturing setting a record low yield for a 20-year index linked bond.

Tuesday’s sale came after the government last week raised forecasts for UK borrowing over the next five years. Achim Linsenmaier, head of SSA Syndicate for Deutsche Bank, said “the long end of the linker market is a good place for the UK DMO to access, a lot of demand is coming from insurance companies and pension funds which naturally need these long dated inflation linked investments”.

Bank of America, Deutsche Bank, Morgan Stanley and Scotiabank advised on the syndicated deal.

Demand for traditional bonds has also remained strong in recent months. Overseas investors snapped up more than £10bn of British government bonds last month, even as bond yields rebounded from record lows set in August. The fixed coupon on gilts means such debt falls in value as yields rise.

Gilts held by non-residents grew £10.55bn last month, softening slightly from the £13.27bn climb in September, but marking the third consecutive month of rises after a contraction in August, according to data from the Bank of England.

Foreign investors own around one quarter of the UK’s outstanding gilt market and play a crucial role in the country’s ability to fund itself at low rates.