UK gets record demand for debt that acts as protection against inflation

The UK received a record level of demand for debt that acts as protection against inflation, with concerns mounting that rising prices aren’t slowing down despite the Bank of England’s interest rate hikes.
 

The £46 billion ($57 billion) order book for £4.5 billion of so-called inflation-linked notes sold on Wednesday was far bigger than any previous UK sale of similar debt tracked by Bloomberg. Data last week showed consumer prices in Britain accelerated 10.1% from a year ago, driven by the strongest increase in food costs in more than four decades.

The huge demand for the bond comes as the UK increasingly looks like an outlier in the global fight to quash soaring inflation. Successive central bank rate increases don’t seem to be making much impact on rising prices in the country, with the March reading coming in well above inflation of 6.9% in the euro area and 5% in the US.

Inflation-linked bonds are typically used by investors as a way of hedging the impact of price rises on their portfolios. They are also particularly popular among UK pension funds that were at the heart of the gilts crisis last year, when they had to offload the securities in a fire sale as interest-rates shot up. 

“This sale would indicate that demand for inflation hedges remains healthy but a lot of demand for inflation-linked gilts is captive demand,” said ING rates strategist Antoine Bouvet, referring to the pension funds. A £3.3 billion reduction in gilt supply compared to an earlier forecast in March may have also helped demand, he added. 

The country’s debt management office offered the notes, due in 2045, with a coupon linked to the retail price index. It set a final spread of 3.75 basis points over an outstanding 2044 inflation-linked bond, according to a person familiar with the matter, who asked not to be identified as they are not authorized to speak about it. 

The order book, which includes interest from the joint lead managers, compares with a UK inflation-linked sale in November that drew £16.8 billion of orders for a £1.5 billion sale. 

Liability-Driven Funds

The sale shows more solid demand for the securities that were at the center of UK market chaos last year, when a sudden rise in rates following former Prime Minister Liz Truss’s fiscal plans sparked mass selling by leveraged pension strategies. That forced an intervention from the Bank of England and contributed to Truss’s downfall.

Since then, those liability-driven investment funds have faced new regulatory scrutiny. Such products should be resilient to bond yields spiking by two-and-a-half percentage points at a minimum, the Bank of England’s Financial Policy Committee said last month. The Pensions Regulator recommended a similar buffer this week.

The UK domestic market took up 93% of the allocation, the debt management office said in a statement. That compares to 78% in the syndicated sale of an inflation-linked bond in November, soon after the gilt market crisis. 

The office offered the bonds at a discount on Wednesday, selling them at a lower price than is implied by Bloomberg’s BVAL estimated fair value for the securities.

“This isn’t necessarily a reflection of outright demand for inflation-linked gilts,” said Megum Muhic, an analyst at RBC, of the sale. “It’s more about the discount offered, which may be encouraging LDI funds to switch into the new bond, particularly given the cheapness of the 20y sector on the broader real yield curve.”