After the biggest gilt remit ever…the second biggest gilt remit
While the gross financing numbers for the current fiscal year were confirmed at a record-breaking £485.2 billion, the forecast for 2021/22 is £302.3 billion, making it the second-largest UK government borrowing requirement in history.
This represented an upside surprise to us and the market, which had expected government borrowing to be around £50 billion less than this, having underestimated the further support measures announced to support the economy through the pandemic.
The Debt Management Office (DMO) now expects to issue £296 billion in government bonds over the next fiscal year, expected to comprise:
• Short conventional gilts: £87 billion (29.4%)
• Medium conventional gilts: £65.4 billion (22.1%)
• Long conventional gilts: £82.8 billion (28%)
• Index-linked gilts: £32.7 billion (11%)
• Unallocated: £28 billion (9.5%)
The DMO foresees conducting six syndications in total, with three long-dated syndications expected to raise £16.5 billion, whilst three index-linked gilt syndications are expected to raise £13.5 billion. The first index-linked gilt syndication is expected to be a new 20-25 year index-linked gilt in the next quarter.
Finally, the DMO also announced that it intended to issue green gilts twice this year, with the aim of raising at least £15 billion, which currently sits in the unallocated portion of the remit.
We are pleased to see the Chancellor has shown a renewed commitment to green gilts. We have engaged the structuring banks on the development of these and will soon be publishing a separate paper specifically on the topic of green gilts.
A number of further ESG initiatives were announced in the budget, including:
• An updated element to the MPC remit to reflect the importance of environmental sustainability and the transition to net zero. This could mean an adjustment to the Corporate Bond Purchase Scheme, though the details have not yet been confirmed.
• A green retail savings product in 2021 to give all UK savers the chance to support green projects.
• A new UK Infrastructure Bank to finance the green industrial revolution. Beginning this spring, it will have an initial capitalisation of £12 billion and is expected to support at least £40 billion of total investment in infrastructure.
We are disappointed that the DMO has not taken the opportunity to increase the issuance of index-linked gilts, given the strong demand we expect to see following the conclusion of RPI reform. Our recent 2021 LDI Outlook piece highlighted that we expect potential demand to exceed supply by around £30 billion over the year. We do, however, expect the average maturity of index-linked gilt issuance to increase this year, in response to renewed demand for longer-dated index-linked gilts.
Despite the suspension of fiscal rules, planned fiscal measures still see the current budget deficit close to elimination by the end of the forecast horizon. This has led to a reduction in planned gilt issuance since the last update, though the high levels of redemptions mean that gross gilt issuance is now projected to average approximately £220 billion annually over the next five years.
A question of maturity
One surprising point that the Office for Budget Responsibility also highlighted was that due to the Bank of England’s quantitative-easing programme, the effective median maturity of public debt has fallen from seven years prior to the financial crisis to below two years currently. This is forecast to fall to less than one year in March 2022.
This highlights the challenge the Bank of England faces in raising rates, despite the more optimistic outlook, as higher rates directly challenge the government’s aims for fiscal consolidation.
The gilt market sold off in response to the budget, moving to price in both the stronger near-term growth outlook as well as higher levels of gilt issuance than had been expected. Longer-dated gilts were the most impacted, with 30-year gilt yields closing the day 0.1% higher than the previous close. Index-linked gilts performed comparatively well, with 30-year breakevens closing around 0.06% wider on the day, as the market priced in lower levels of index-linked gilt issuance than had been expected.
We believe the recent selloff in government bonds could provide attractive valuations for LDI clients to continue to hedge their liabilities. The chart below shows an illustrative funding ratio over time for a typical pension fund. Whilst markets have proven volatile over recent weeks, the Bank of England continues to buy large amount of gilts through its quantitative-easing programme and we believe rates are likely to stay on hold for a long time, particularly since the government now aims to deliver some fiscal tightening once the pandemic passes.
 Source: Bloomberg, 4 March 2021