The great bond fandango

The market for British bonds, or gilts, used to fund government borrowing is one of the least understood parts of the nation’s financial architecture. A harsh temporary light was shone on gilts during Liz Truss’s short sojourn on Downing Street when her tax cutting caused market interest rates to surge and sent a shock cascading through UK pension funds.

Asset managers unwisely sought to bolster returns through the use of liabilitydriven investments, a type of derivative, turning the safest of holdings into ticking time bombs.

That experience, which required the Bank of england to come to the rescue of the nation’s pension funds, is deeply ingrained in the psyche of the Treasury. It is among the reasons why there is so much fear about challenging the wisdom of the Office for Budget Responsibility (OBR).

Defying the OBR could potentially foment a revolt among ‘bond vigilantes’. These specialist traders seek to exploit the fiscal laxity of sovereign governments.

Three successive shocks since the millennium – the great financial crisis, the pandemic and Russia’s war on Ukraine – have seen the UK’s debt and borrowing escalate. The scale of the task has thrust the Debt Management Office (DMO), an obscure offshoot of the Treasury, into the frontline of policy.

Students of debt markets turn to Annex A of the ‘red book’ on Budget day to understand how much new money needs to be raised to keep the show on the road.

The net financing requirement in the year which ends on April 5 was put at £246.1bn in the autumn statement. It projects a further £276.9bn will be needed in 2024-25.

A just-released report by the Public Accounts Committee (PAC) is stinging in its criticism of the way the debt markets are managed. It wants to see better monitoring to spot unlawful activity.

Competition regulators discovered unlawful sharing of sensitive information by five leading banks in the period 20092013 when borrowing soared after the bailout of the financial system.

The PAC wants to see more disclosure of who actually owns Britain’s debt.

In spite of the negativism about the UK, which fills the airwaves, foreigners actually trust Britain and hold some 25pc of our debt. That is the highest level in the G7 other than France. The scale of overseas ownership is a risk factor.

POLITICAL and economic chaos potentially could trigger a run on gilts by overseas owners sending yields, the return on bonds, soaring and disrupting plans for bond auctions.

The report also highlights the growing challenge for the DMO as it offloads ever more bonds.

This at the same time as the Bank of england is a net seller of bonds (£100bn is scheduled for this year) as it unwinds its holdings of £875bn.

The Bank’s bond-buying spree, or quantitative easing (Qe), began with the great financial crisis but didn’t end until the new inflation loomed into view in 2021.

The make-up of UK borrowing has two unusual characteristics.

On the positive front, the maturity – the length of time the money is borrowed – at 14 years is the longest in the G7.

That is more than twice the US at six years and ought to act as a source of stability and locked in some lower interest rates.

The big misjudgement, exposed during the recent period of surging prices, was the decision to issue 25pc of our debt in inflation-linked index bonds.

As the cost of living soared in 2021-22, the burden of servicing the debt mountain climbed. This crimped the flexibility of successive Chancellors.

It is among the key reasons why public services have been starved of resources and individual and corporate taxes have been increased to record levels.

establishing responsibility for a huge mistake is difficult.

Suffice it to say, the big build-up of indexlinked gilts occurred when George Osborne was Chancellor.

There was a widespread belief that the inflation demon had been slain. how wrong you can be.