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The UK government has been told to scale back its issuance of long-dated and inflation-linked bonds as pension funds’ appetite for such debt wanes in a “significant structural change” to demand.
Gilt issuance plans for the 2024-25 financial year should take into account a reduction in demand of longer maturity gilts, “in particular from the domestic pension fund sector”, the minutes of an annual meeting between the UK’s Debt Management Office, bond dealers and investors showed on Tuesday.
The UK’s large private pensions industry has long been a cornerstone of the gilt market. Pension funds own about a quarter of outstanding gilts, and they are particularly dominant in bonds with maturities of 30 years, as well as inflation-linked debt, both of which they use to hedge their long-term obligations to scheme members.
The central role played by these “liability-driven” investment strategies was underlined by the gilt crisis in 2022, when a wave of forced selling by pension funds sent the market into freefall.
However, demand for gilts from pension funds has begun to ease in recent years as schemes reach maturity and no longer have the same hunger for government debt. At the same time, most defined benefit pension schemes are closed to new members, so they are no longer growing in size.
“Strong support was expressed for a proportionate reduction in long conventional issuance next year relative to 2023-24” the minutes said. Investors also called for a reduction in the proportion of inflation-linked debt.
Signs of a shift in gilt demand come as the UK plans to sell record volumes of debt. In November the Office for Budget Responsibility estimated the government’s gross financing requirement would be £277bn in 2024-25, about 16 per cent higher than the UK’s debt sales this year.
The DMO will announce its 2024-25 issuance plans on March 6, after chancellor Jeremy Hunt presents his annual budget.
Imogen Bachra, head of non-dollar rates strategy at NatWest, said she expected the shift to shorter-dated gilts to be gradual because “there is still so much issuance to be done that the DMO will have to issue across the curve in relatively big size in order to not flood one particular part of the market”.
Still, the move to issue more shorter-dated debt could slowly bring the gilt market into line with other major bond markets. The average maturity of UK debt stands at nearly 15 years, about double the US Treasury market, a legacy of pension funds’ insatiable appetite for long-term debt over the past few decades. The share of inflation-linked bonds is also far higher than other nations at about a quarter.
The unusually high average maturity has insulated the public finances from sudden changes in market conditions, because it takes longer for moves in yields to feed through to the government’s overall interest costs. But the large share of inflation-linked debt also handed the Treasury a hefty interest bill in recent years as prices surged.
“The risk with skewing issuance shorter is that the UK becomes much more exposed to refinancing risk in the future,” said Craig Inches, head of rates and cash at Royal London Asset Management.
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