MNI INTERVIEW: UK Pension Shift To Sap Linker Demand: DMO Head

--Stheeman Still Envisages Ultra-Long Issuance, But To Lesser Extent

--Defined Benefit Schemes' Demise Very Gradually Transforming UK Gilt Market

By David Robinson

     LONDON (MNI) - The winding down of defined-benefit pension schemes has

shifted funds towards shorter-dated U.K. Treasury bonds, and will ultimately

reduce demand for longer maturity and inflation-linked gilts, Debt Management

Office Chief Executive Robert Stheeman told MNI.

     While Stheeman stressed in an interview that defined-benefit schemes remain

a major force at the long end of the market, many are now closed to new

entrants, coinciding with a gradual shift in the point of strongest marginal

demand on the yield curve from the 30- to 40-year segment towards 30 years and

"maybe even into the 20- to 30-year area."

     "That is something that we have noted in particular over the past 12 to 18

months," said the DMO head, speaking to MNI at the Euromoney Bond Investors

Forum last week and in a subsequent email exchange.

     "DB pension schemes are massive, long-dated and by their nature have

liabilities that are under-hedged and still growing despite the declining number

of new entrants to schemes," Stheeman said. "In the very long term, the shift

from defined benefit to defined contribution schemes will decrease the demand

for long dated bonds and linkers.

     "However, this transition is a bit like turning a supertanker travelling at

speed."

     The yield curve actually dips beyond the 30-year point, which "tells you

where the domestic demand is," Stheeman said, with 30-year plus yields close to

all-time lows.

     --LESS LINKERS

     Stheeman is in favour of curbing the growth of inflation-linked issuance to

reduce the UK's vulnerability to an inflation shock.

     The UK is an outlier internationally, with just over 26% of its debt

portfolio inflation linked, around double the next closest country, Italy, and

compared to 9-10% in the U.S. With the possibility of further sterling weakness

due to Brexit, upside UK inflation risks are all too real.

     "As part of the government's responsible approach to fiscal risk

management, we are looking to reduce the proportion of index-linked gilt

issuance as a share of total issuance over the medium term," he said.

     The DMO's planned reduction in inflation-linked issuance in the 2019-20

fiscal year is around 2 percentage points but Stheeman said that "we don't have

a target" for the pace of reduction going forwards.

     The latest official data has shown some softening in institutional gilt

demand. Insurance companies, pension funds and trusts in the fourth quarter

reported net disinvestment of stg0.4 billion in gilts in the fourth quarter 2018

compared to a five-year quarterly average net investment average of stg4

billion.

     The challenge for the DMO is to avoid failing to meet demand while also

tackling inflation exposure.

     "We need to be mindful of striking a balance between exposure to inflation,

achieving value for money, predictability and efficient market function. We will

therefore try to remain flexible in order to give us the ability to react to

changes in rates and market conditions as they arise," Stheeman said.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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