The UK government revived a centuries-old tradition earlier this year when it convened a meeting of the Commissioners for the Reduction of the National Debt for the first time since 1860. Over dinner at the Treasury, the governor of the Bank of England, Lord Chief Justice and head of the UK’s Debt Management Office discussed Britain’s record £1.5tn debt pile and the then chancellor George Osborne’s proposal that the UK should in future only borrow money under exceptional circumstances.
There are no plans for a second meeting. The turbulence created by Britain’s vote to leave the EU in the intervening months ended Mr Osborne’s role at the Treasury, and put an end to government plans for a budget surplus by 2020. Philip Hammond, the UK’s new chancellor, has signalled that after years of fiscal conservatism the government is poised to begin a new phase of borrowing to mitigate the effects of Brexit.
“There has been an about-turn,” says Philip Brown, head of supranational, sub-sovereign and agency debt capital markets at Citigroup. “And it is the source of intense interest in markets.”
The job of selling British debt — one of the oldest securities in the world whose roots can be traced back to King William III’s desire to fund a war in France — should be relatively straightforward. Domestic and international investors regard the UK as a safe bet. And the Bank of England’s decision to restart a bond-buying programme worth an additional £70bn and cut interest rates to 0.25 per cent — the lowest in its 322-year history — following the referendum led investors to reprice government bonds, known as gilts, at new highs this summer.
At the same time, with central banks in Europe and Japan engaged in monetary easing and the US hesitant over any further rate rise, there has been a rush to bonds that has given gilt investors double-digit total returns in the first eight months of the year, beating the FTSE All-Share index. As rising prices mean lower yields, the rally has provided record-low borrowing costs for the government. In September 2007, the UK’s 10-year borrowing rate was 5 per cent. Now it is less than 1 per cent.
But successfully placing billions of pounds of debt is a complex process in which the UK must compete for investors. “There are some investors that have to buy gilts but others can choose depending on how attractive the price looks,” says Mike Riddell, a fund manager at Allianz. “Every sale is a test of whether the market is working in the way it should.”
Sir Robert Stheeman, the 57-year-old former banker who has run the UK’s DMO for the past 13 years, is fond of using the word “boring” to describe successful operations. “To assume the [market] moves are just one way is naive and short sighted,” he says. “Yields are at extraordinary low levels historically, but there is nothing in the rule book that says they will stay there forever. It generally pays to be circumspect.”
The market is already showing signs of concern about just how long the rally in gilts can last. In recent days, a sell-off has raised yields. Dwindling appetite from international investors, improving economic data and a fiscal policy that increases the supply of gilts all pose potential threats. Previous market meltdowns suggest that with yields so low, the sell-off could be sharp. In a matter of days, rates could jump by whole percentage points — making future government borrowing more expensive.