UK gets record demand for bonds hedging against inflation

THE UK received a record level of demand for debt that acts as protection against inflation, with concerns mounting that rising prices aren’t slowing down, despite the Bank of England’s interest rate hikes.

The £46 billion (S$76.6 billion) orderbook for £4.5 billion of so-called inflation-linked notes sold on Wednesday (Apr 26) was far bigger than any previous UK sale of similar debt tracked by Bloomberg. Data last week showed consumer prices in Britain accelerated 10.1 per cent from a year ago, driven by the strongest increase in food prices in more than four decades.

The huge demand for the bond comes as the UK increasingly looks like an outlier in the global fight to quash soaring inflation. Successive central bank rate increases don’t seem to be making much impact on rising prices in the country, with the March reading coming in well above inflation of 6.9 per cent in the euro area and 5 per cent in the US.

Inflation-linked bonds are typically used by investors as a way of hedging the impact of price rises on their portfolios. They are also particularly popular among UK pension funds that were at the heart of the gilts crisis last year, when they had to offload the securities in a fire sale as interest-rates shot up.

“This sale would indicate that demand for inflation hedges remains healthy but a lot of demand for inflation-linked gilts is captive demand,” said ING rates strategist Antoine Bouvet, referring to the pension funds. A £3.3 billion reduction in gilt supply compared to an earlier forecast in March may have also helped demand, he added.

Some hedge funds also take a view on inflation by betting on inflation-linked bonds such as those issued by the UK and US.

The country’s debt management office (DMO) offered the notes, due in 2045, with a coupon linked to the retail price index. It set a final spread of 3.75 basis points over an outstanding 2044 inflation-linked bond, according to a person familiar with the matter, who asked not to be identified as they are not authorised to speak about it.

The orderbook, which includes interest from the joint lead managers, compares with a UK inflation-linked sale in November that drew £16.8 billion of orders for a £1.5 billion sale.

Liability-driven funds

The sale shows more solid demand for the securities that were at the centre of UK market chaos last year, when a sudden rise in rates following former prime minister Liz Truss’s fiscal plans sparked mass selling by leveraged pension strategies. That forced an intervention from the Bank of England and contributed to Truss’s downfall.

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Since then, those liability-driven investment funds have faced new regulatory scrutiny. Such products should be resilient to bond yields spiking by two-and-a-half percentage points at a minimum, the Bank of England’s Financial Policy Committee said last month. The Pensions Regulator recommended a similar buffer earlier this week.

The DMO offered the bonds at a discount, selling them at a lower price than is implied by Bloomberg’s BVAL estimated fair value for the securities. BLOOMBERG