UK government bonds turn negative and extend historic rally

UK government bond yields entered negative territory on Wednesday, extending a historic rally after the Bank of England stressed its commitment to buy up gilts in a bid to stimulate the economy.

Such was the demand for near-term UK debt that yields on UK government paper due in March 2019 and March 2020 fell to minus 0.017 per cent and minus 0.015 per cent, respectively. In effect, investors are paying to hold the debt to maturity.

The move came as yields across Europe also fell. Irish 10-year debt was yielding 0.325 per cent last night, having touched a new record of 0.319 per cent in earlier trade. The yield on Germany’s 10-year bonds fell 1.4 basis points to minus 0.16 per cent, while 30-year bond yields were 1.8 bps lower at 0.40 per cent.

The amount of global negative-yielding debt has now risen to $12.64 trillion according to Tradeweb, and is dominated by European and Japanese bonds.

Only once before have UK gilt yields turned negative – briefly following the country’s vote to leave the EU. The slide back has raised investor expectations that the UK is joining a club of nations, dominated by Japan and Europe, with negative-yielding government debt.

The yield on UK 10-year benchmark debt hit a record low on Wednesday, falling 3.9 basis points to 0.541 per cent. The benchmark was yielding 1.40 per cent before the Brexit vote in June.

The rally in bond prices, which move inversely to yields, follows the Bank of England’s failure to find enough sellers for the £1.17 billion it sought to spend on long-dated paper on Tuesday, with some pension funds and insurance companies struggling with a deepening funding crisis unwilling to sell such gilts.

The bond purchases by the Bank of England are aimed at raising the price of the bonds and lowering their yield, pushing investors to look elsewhere to find higher returns, such as lending to companies. Lower yields also reduce the cost of borrowing for companies and individuals. Policymakers hope both incentives will spur investing in the real economy and restart growth.

The Bank of England said on Wednesday it planned to make up for a £52 million shortfall in its $1.17 billion auction with additional purchases later.

The shortfall raised doubts about the central bank’s quantitative easing scheme – which is currently focused on debt with maturities of seven years and above. But it also encouraged investors to buy shorter-term gilts, pressuring yields lower.

“The decline not only reflects the expectation of lower growth and a 0 per cent central bank policy rate, but it is also the result of the Bank of England’s decision to purchase gilts on the secondary market,” said Markus Allenspach, head of fixed income research at Julius Baer.

Darren Ruane, head of fixed income at Investec Wealth, said “medium term gilt yields can fall to as low as the base interest rate, either 0.25 per cent or perhaps 0 per cent if we have a second interest rate reduction in the UK”.

“Short-dated government bond yields can fall through the base rate as some investors cannot get access to the base rate and look for alternatives, pushing up the price.’’

Darren Bustin, head of derivatives at Royal London Asset Management, said the Bank of England’s statement meant it was “kicking the can down the road” and that should monetary policy fail to achieve its goals, a stronger fiscal stimulus would be needed for the economy.

The Bank of England cut interest rates for the first time since 2009 last week and resumed its quantitative easing programme to cope with the fallout of Britain's decision to leave the European Union. – Copyright The Financial Times Limited 2016