The results of the Bank of England’s latest £2.5bn gilt asset purchase buyback on Monday confused us a bit at first. Here are the Reuters snaps:
- BANK OF ENGLAND SAYS GETS 3.65 COVER RATIO IN PURCHASE OF 2.5 BLN STG OF LONGER-DATED GILTS
- BOE SAYS BUYS 0 MLN STG OF 2020 4.75 PCT GILT
- BOE SAYS BUYS 2,050 MLN STG OF 2021 8.00 PCT GILT, AVERAGE PRICE 143.614
- BOE SAYS BUYS 112 MLN STG OF 2025 5.00 PCT GILT, AVERAGE PRICE 110.470
- BOE SAYS BUYS 17 MLN STG OF 2027 4.25 PCT GILT, AVERAGE PRICE 100.840
- BOE SAYS BUYS 75 MLN STG OF 2028 6.00 PCT GILT, AVERAGE PRICE 124.607
- BOE SAYS BUYS 246 MLN STG OF 2030 4.75 PCT GILT, AVERAGE PRICE 107.561
- BOE SAYS BUYS 0 MLN STG OF 2032 4.25 PCT GILT
With a 3.65x cover the buyback was very well subscribed, so well subscribed in fact that the BoE was actually forced to make no purchases at all in some specific long-dated gilt issues eligible from the 10-25 range being accepted.
So what does that mean? John Kemp, columnist at Reuters, believes this is symptomatic of the BoE’s quantitative easing programmes backfiring spectacularly. As he explains (our emphasis):
With so much money creation at national and international levels, investors are now so worried about the medium and long-term outlook for inflation that they are rushing to sell unwanted government debt back to the central banks . In fact, they want to sell more than the central bank wants to buy.
But with the rest of the market a seller-over, bond prices have started to soften, and yields rise. The problem with all this yield curve manipulation, in both the United States and the United Kingdom, is that by creating an artificially high price the central bank risks becoming the ONLY buyer for government bonds, as everyone else rushes to offload increasingly risky paper. Like the Hunt Brothers, the Tin Council, and a host of other market participants who thought they could control prices, the Bank of England, and the Fed, are about to get a sharp lesson in the problem of market management.
If the Bank of England does risk becoming the only buyer for government bonds as Kemp suggests, this presumably means liquidity and volumes in secondary markets will be going down too. Does this risk stalling the entire market?
Meanwhile, the inflationary-minded consequences are already spilling through to the mortgage market.
Ray Boulger, mortgage expert at industry advisory firm John Charcol tells FT Alphaville he is already advising clients to fix into five and 10-year deals. Of course, the exact timings will depend on client circumstances. For example those with relatively low loan-to-value (LTV) deals — or at least anything below 75 per cent — might consider waiting a while to benefit from the exceptionally low variable rates on the market.
However, those whose LTVs are perilously close to breaking through the key 75 per cent figure as property prices decline further might be better off taking a fixed deal as soon as possible. As he says:
“We don’t know when the rates will go up but there is a big risk that when they do they will go up quickly. And they could very well go in excess of the previous cycle’s peak of 4.75 per cent. “
Separately, in a piece entitled “Time to buy a fixed rate” posted on March 25th he commented as follows regarding the obvious shift in mood in the gilt market:
The marked change of mood this week has pushed yields back up, to such an extent that 5 year gilts now yield a little more than prior to the Q.E. announcement, although yields on some of the longer dated maturities are still well down on the month. Swap rates have in general gone back up to their level prior to the Q. E. announcement and some shorter dated swaps are actually now a little higher. This is bad news for fixed rate mortgage pricing and hence my expectation that we will see some lenders start to re-price upwards as early as next week.
The key reasons for the sharp rise in gilt yields this week are:
* Yesterday’s shock inflation figures.
* Mervyn King’s comments to the Treasury Select Committee yesterday, effectively telling Gordon Brown to stop flexing the corporate credit card.
* Today’s failure of the long dated gilt auction, the first such failure, excluding index linked gilt auctions, for 14 years, with only 93% of the gilts on offer being taken up..
So with index-lined bonds clearly most in demand the market consensus on the great inflation/debate seems to be clear. Consequently, perhaps it is better to fix that mortgage before, as Boulger states, the providers do begin to re-price rates in line with gilt yield fluctuations.
On a side note, if you thought Boulger’s view on interest rates was bleak, it’s worth checking out his more recent blog posting on the health of the UK’s finances for some even greater doom — Boulger wonders if the government might actually be softening the UK up for an IMF bailout. As he writes:
Two Ministers on the same day making the point that there is no longer a stigma calling on the IMF for a loan sounds like more than a coincidence. Add Mandleson’s comment that “We won’t be at the top of the queue” and it suggests we are being softened up for Alistair Darling to take the begging bowl to the IMF.
Related links:
Gilt auction failure begins – FT Alphaville
Swinging gilts – FT Alphaville
JUMP Bankers! – FT Alphaville
Rejoice! – UK house prices rise – FT Alphaville
UK house prices rise (surely some mistake, eh?) - FT Alphaville