MNI INTERVIEW: UK DMO To Meet Linker Demand As Inflation Jumps

The UK's Debt Management Office is reversing a drive to cut back on the proportion of gilt issuance that is inflation-linked as surging retail prices feed strong demand from domestic pension funds, DMO head Robert Stheeman told MNI.

"We had reduced linker issuance over the last couple of years as a proportion of our overall issuance, reflecting the government's aim to limit its exposure to inflation risk and the reform of RPI. We have been conscious of the fact that this reduction has happened in the face of continued, ongoing, structural demand from the UK pensions industry for inflation-linked products," Stheeman said in an interview. "We have not tried to take an axe to the linker issuance total."

The strength of demand made the DMO keen to preserve a linker syndication scheduled for November, he said, speaking Wednesday after the largest reduction on record in the UK's financing requirement, of GBP82.8 billion, as public finances came in far stronger than expected after the initial Covid hit. While the cut in planned gilt sales is GBP57.8 billion in the 2021-22 financial year, linkers only accounted for GBP2.1 billion of the reduction.

The UK has a little under a quarter of its debt stock in linkers, a far higher share than other sovereigns, and it was this relatively greater exposure to rising inflation which prompted the earlier drive to reduce issuance.

As inflation rises and market rate expectations see Bank Rate at 1.25% by the end of next year, speculation has built over what the Bank and the DMO would do if both were to simultaneously sell gilts. Under the BOE's new approach to quantitative tightening, it will cease reinvesting maturing gilts when Bank Rate, currently at 0.1%, reaches 0.5% and to consider selling bonds at 1%.

RISK OF BOE GILT SALES

Stheeman stressed that the BOE has always been sensitive to this risk.

"Because any future sales (of gilts held in the APF) .. is so fundamentally a monetary policy issue the responsibility naturally lies with the Bank of England. That does not, however, mean that the authorities are blind to, or don't care about the possible impact, of having two sellers acting in the market at the same time," he said.

He added that "the Bank has always said that it would unwind QE in a way that they hope is neither disruptive to the market and, in particular, in consultation with the DMO on operational matters."

The cut in planned gilt sales appears, from the financing arithmetic, to come largely from shorter- and longer-term debt, with medium-term issuance increasing, but Stheeman stressed that the aim was not to change the shape of the curve, noting that medium-term issuance plans were distorted by the launch of the government's green bond programme.

"We have tried to keep the balance between short, medium and longs more or less the same across the curve for the year," he said.

"Our aim was very much … not to fundamentally change the overall shape of the issuance profile as decided at the beginning of the year for the annual remit," he added.

Alongside the cut in planned gilt sales, the DMO also announced a GBP25 billion reduction in Treasury bill sales. That was a signal to make clear that "we do not ask the gilt market to make the entire GBP82.8 billion adjustment on its own. We are mindful of the importance of supporting market liquidity where we can," Stheeman said.