(Bloomberg) -- Nobody likes paying over the odds for something, right? Well maybe it has its upsides when it comes to the Bank of England's government bond purchases.
The BOE paid a premium for all the long-dated gilts bought at an operation on Tuesday after it drew offers of just 1.5 times the amount sought. The bank is buying 1.17 billion pounds ($1.5 billion) of the bonds each week under its new QE program, part of a package of measures designed to combat the economic fallout of Brexit.
While this is the second time in three weeks that the central bank has had to pay above the market price for bonds with a maturity of at least 15 years, John Wraith, the head of U.K. rates strategy at UBS Group AG in London, says concerns miss the point.
Since QE started this month, the yields on five-, 10- and 30-year gilts have all dropped to record lows.
``Don't forget one of the aims of QE is to lower the yield on safe haven assets to help lower borrowing costs throughout the economy, and to encourage investors to diversify into riskier assets,'' Wraith said. ``In other words, for the BOE, paying up like this is in some ways a good thing as it boosts the intentional impact of QE. And anyway, there are still plenty of long bonds out there if they pay up enough.''
So far, the BOE's response has been sanguine. It can alter the size of operations and the gilts eligible for purchase at any stage during the program. It plans to deal with the 52-million pound shortfall from its uncovered Aug. 9 operation at a later date. The central bank declined to comment on Tuesday on the latest operation.
``In weeks like this when we haven't got long-dated supply, I think it's probably reasonable to expect lower submission-cover ratios and to expect that the BOE may well have to pay a bit of a premium,'' said Simon Peck, a fixed-income strategist in London at Royal Bank of Scotland. ``There is a clearing price for everything.''
But there's still residual concerns about the prices paid and the uncovered auction in just the first week of QE. Those worries center on the risk that the BOE might not be able to find enough of the bonds to meet its target over the six-month program. Yield-hungry investors may be less willing to part with longer-term bonds that tend to offer higher yields and which are in particular demand from pension companies.
That raises the spectre of investors demanding higher premiums, leaving the BOE with a choice between paying inflated prices or risking the embarrassment of more shortfalls.
There's also the perception problem of banks getting ever higher prices for the assets. The BOE already saw protesters against QE on its doorstep last week, and more headlines about its struggles to implement the program risk flaming further criticism.
``The concern is that it's happened now, and there's still a few more weeks of long end buybacks, so who's going to be selling?'' said Daniela Russell, a portfolio construction associate at Legal & General Group Plc, the biggest manager of U.K. pension money. ``It has been covered, there's no great concern, but if you were to see a series of uncovered buybacks it would certainly raise the risk that they are pushed to review the structure of the buying program before November.''