International investors bought the most UK government debt in almost a year in September, as turbulence in the pound failed to dent overseas appetite that has helped keep a cap on Britain’s borrowing costs.
Investors from outside the UK increased their holdings of gilts by £13.3bn in September, data from the Bank of England showed on Monday, a sharp rise on the £1.8bn added in August and the heftiest purchases since October 2015.
Since the vote for Brexit in June, overseas demand for gilts has been closely tracked given international investors own roughly a quarter of the £1.6tn market that sets the government’s borrowing costs and is a benchmark for companies. Before the referendum on EU membership, the Treasury warned a vote for Brexit could spur heavy selling of gilts from outside the UK.
Gilt prices did fall in the first half of September before closing out the month up from their lows, with the 10-year benchmark yield ending at 0.74 per cent. Yields move in the opposite direction to a bond’s price. The pound weakened 1.3 per cent in the month.
October has proved much more brutal as Brexit-inspired weakness in the pound rattled the sovereign debt market. The pound has slumped 6 per cent to below $1.22, helping to send the yield on the 10-year gilt to 1.24 per cent as the faltering currency raises fears of inflation among bondholders.
Gianluca Salford, senior European fixed-income strategist at JPMorgan, cautioned BoE data that looked positive may not have captured the full extent of international investor positioning, pointing out the fresh weakness in the pound will have widened losses for anyone converting returns into another currency.
Both the pound and gilts have been under fire since the start of October, when Britain’s prime minister, Theresa May, used the Conservative party conference to signal the government was pursuing a hard Brexit that prioritised control over migration, and attacked the BoE’s stimulus policies for harming savers.
Bondholders say the shift in political rhetoric towards the BoE and governor Mark Carney has contributed to this month’s selling.
“The political and market consensus in support of central banks doing whatever it takes to support the economy is fracturing,” said David Riley, head of credit strategy at BlueBay Asset Management. “The low interest rate policies and quantitative easing — large-scale asset purchases — by the world’s major central banks are increasingly under attack from politicians.”
In the wake of the vote for Brexit, the Bank of England opted to cut interest rates to a 322-year low and restart a £70bn quantitative easing programme to bolster the economy, encouraging a rally in gilts.
However, the move has drawn loud complaints from pension funds who argue low rates widened deficits, while banks say that ultra-low interest rates obstruct their business model.
“It seems from the price action that there is a lot more concern about the UK following comments about ‘hard Brexit’,” said Mitul Patel, head of interest rates at Henderson Global Investors. “This is still an economy that requires stimulus — but stimulus is no longer the base case investors expect.”
Globally, central banks are still buying more assets every month than at any time since the global financial crisis. But as inflation threatens a comeback and criticism of central bank policy increases, global bond markets are selling off. In October, major bond markets returns suffered the sharpest drop in total returns since May 2013, according to data from JPMorgan.
Fraser Lundie, co-head of credit at Hermes, points out that rates in bond markets remain low by historical comparisons. “This is not yet the reversal of a multiyear trend,” he said. “But it is a wake-up call.”