U.K. Readies Bond Market Supply Hit as Decade of BOE Buying Ends

(Bloomberg) -- The U.K. is about to finance a year of spending without help from the Bank of England for the first time in over a decade.

The nation’s Debt Management Office is seen issuing 152 billion pounds ($201 billion) of gilts in the fiscal year from April, down from 195 billion pounds for the past year, a Bloomberg survey of 15 primary dealers showed. Investors could still be hit with a record volume of debt, once BOE action and redemptions are taken into account, Bloomberg Intelligence estimates using data going back to 1991.

That could further weigh on a market that has slumped this year as the BOE hikes interest rates, with 10-year yields surging to the highest since 2018. Still, a scarcity of bonds has distorted parts of the market and the extra supply heralds a return to some form of normality for dealers. 

“I’m looking forward to that onset of supply to improve market functioning because primary market dealers and private market participants will have paper to move around,” said Rohan Khanna, a rates strategist at UBS Group AG. “There will still be volatility from geopolitical shocks and monetary policy pivots, but I think it will go some distance in trying to bring a sense of calm to the market.” 

The paucity of bonds in recent months has driven the premium on short-end gilts versus swaps to a record this year, according to Tullet Prebon data going back to 2013. Dealers were forced to resort to a DMO backstop facility to source a particularly scarce bond, after investors rushed for havens following Russia’s invasion of Ukraine.

There’s still plenty of uncertainty over the projections for supply. Estimates for sales in the survey ranged from 108 billion pounds to 211 billion pounds. The divergence is partly down to the extent to which the DMO will replenish its T-bill stock, which would alleviate the need for gilt sales. It cut bill supply in October, causing wild gyrations.

“We’ve seen some strain in the repo markets for short-end gilts given the scarcity in that sector, and so a greater issuance of T-bills and short-dated gilts would hopefully ease some of those pressures that we have been seeing,” said Daniela Russell, a rates strategist at HSBC Holdings Plc, who sees T-bills contributing around 23 billion pounds.

There’s also uncertainty over how much money the government will need, ahead of U.K. Chancellor Rishi Sunak’s spring statement on Wednesday. He’s pledged to help Britons with a cost-of-living crisis, with policy options including a cut to fuel duty and raising the threshold at which people start paying national insurance, a payroll tax that’s set to rise next month. 

Then there’s debate on how higher-than-expected tax receipts will change the picture. Data on Tuesday showed the country’s budget deficit running 26 billion pounds below official forecasts in the first 11 months of this fiscal year. 

“We’re seeing a wide range of forecasts just because public finances are so opaque at the moment,” said David Parkinson, sterling rates product manager at RBC Capital Markets, adding that investor positioning was light at the longer end of the gilt curve that is seen as more sensitive to changes in supply. “It’s just not a good background for taking a lot of risk.”

Beyond the headline gilt sales figure, focus will be given to how much of the new remit is made up of inflation-linked bonds, which have traded at the most expensive relative to conventional debt in decades, as investors look to hedge against price increases. The amount of green bonds the DMO aims to sell will be important to the U.K.’s aim to build a market curve for the securities.

Bond strategists are also looking ahead to when the BOE will take the next step in removing stimulus, by starting to actively sell bonds from its roughly 850 billion-pound portfolio.

It’s a move policy makers said they will consider once the key BOE rate reaches 1%, which money markets see happening in May. Bank of America Corp. and JPMorgan Chase & Co. are among banks that see this quantitative tightening kicking off in November, with the latter forecasting 2-3 billion pounds of sales per month from that point.

Bloomberg Intelligence’s estimate for a record level of market supply includes active gilt sales of 5 billion pounds a month from October, and is premised on 190 billion pounds of gross issuance. Even without any active QT, RBC Capital Markets estimates the highest effective net volume of gilts since 2013-14.

“People have been trying to factor QT into their view, but given that it’s seen to be more likely to come at the latter end of the calendar or even fiscal year, the mindset is more to focus on the remit as the next piece of the jigsaw puzzle,” said RBC’s Parkinson.

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