Investors could offer bonds at negative yields in future BoE auctions

The Bank of England saw strong participation in yesterday’s government bond-buying spree as part of its quantitative easing (QE) programme, but Tuesday’s failure by the bank to meet its long-bond buying target could lead to negative yield offers from investors in future operations.

The UK central bank’s reverse auction yesterday met with offers to sell medium-dated Gilts outstripping demand by almost five to one, after Tuesday’s long-bond reverse auction had been partly stymied by pension funds unwilling to sell.

The bank announced last week that it aims to buy £60bn (€70bn) in UK government debt in the next six months as part of measures to boost the country’s economy.

But on Tuesday, the bank failed to reach its £1.17bn target in its first attempt to buy Gilts, aiming for bonds with maturities of 15 years or more, with the operation failing to draw enough sellers.

However, yesterday’s reverse auction, which targeted the 7-15 year maturity band, did not face the same problems.

The bank said it received offers to sell around £5.5bn of the bonds sought, and did purchase its targeted £1.17bn of securities.

Commentators said the shortfall on Tuesday showed pension funds were short of these long-dated bonds, with one adding that investors were likely to offer at lower yields in subsequent auctions, having seen the lack of sellers.

Toby Nangle, head of multi-asset allocation for the EMEA at Columbia Threadneedle Investments, said: “We anticipate that the failure to buy the full amount of Gilts required in future auctions will not be repeated on account of insufficient offers.

“Given the news that [Tuesday’s] reverse auction went uncovered, active investors are likely to submit offers at yields well below market levels, perhaps even below 0%.”

The Bank of England has said it will incorporate the £52m shortfall from Tuesday’s uncovered operation into the second half of its current six-month purchase programme.

Details of these purchases will be announced on 3 November, it said.

Nangle said that, by his calculations, there is not enough UK interest rate duration to let defined benefit (DB) pension funds match their actuarially estimated liabilities with fixed income assets, in spite of regulatory incentives to so do.

“Put another way, pension funds are collectively short long-dated Gilts and, in re-initiating its QE programme, the bank has found itself delivering a short-squeeze – the effect of which is to increase pension fund deficits further,” he said.

The Bank of England’s assertion in its recent inflation report that DB pension schemes would be able to maintain current levels of contributions despite fluctuations in deficits looks likely to be tested, he said.

Shilen Shah, bond strategist at Investec Wealth & Investment, said Tuesday’s auction highlighted the fact that a number of investors at the long end of the curve are largely price insensitive and potentially unwilling to sell their Gilt holdings.

“Given the narrow investment mandate of many liability-driven investors,” Shah said, “the alternative investment options to long-dated Gilts for these investors is very limited.”