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Treasury officials have been warned that waning demand for long-term gilts leaves the UK in danger of repeating the market chaos seen in the wake of the mini-budget.
Senior bankers and pension fund managers held meetings with the Debt Management Office (DMO) and Bank of England ahead of the March 6 Budget at which they warned that the UK risked suffering its first failed debt auction in 15 years.
City figures fear that supply will outstrip demand within the next 18 months as the Government prepares to issue historic amounts of debt and as seismic changes in the pension industry turn retirement funds from buyers to sellers. Concerns are focused specifically around demand for long-term debt, which matures over 20 years or longer.
Officials have been told of the issue in the past but the warning about a potential failed auction is thought to be the strongest caution yet.
The Government announced plans in the Budget to reduce the amount of long-dated debt it will issue this year by more than expected following the meetings. The DMO, which sits within the Treasury, said it would issue £53bn this year and £49bn in the next financial year, even as the overall number of bonds increases.
The changes appear designed to ease market concerns and ensure the Government is selling the right type of debt to satisfy demand.
However, some leading City figures say favouring more short-term debt is unlikely to solve the problem and current plans still risked a repeat of the chaos seen in the wake of former prime minister Liz Truss’s mini-budget.
“There is a gap between supply and demand and it doesn’t seem the changes in the remit recognise this problem,” said one major pension fund manager.
“Given there could be a failed future long auction, could there be a repeat of 2022 if DMO doesn’t get this right? It’s something that needs serious attention.”
While a failed auction may sound minor, it would threaten to trigger a wider confidence crisis in the Government’s ability to fund itself. Such a panic is what led to the bond market instability in the wake of the 2022 mini-Budget.
The last failed auction was in 2009 in the wake of the financial crisis, when the DMO attracted just £1.62bn of bids for a sale of £1.75bn of 40-year gilts.
Concerns stem from changes within the pension industry. City figures warned officials that net demand for long-dated debt from the defined benefit (DB) pension industry was likely to be less than £40bn, when taking into account sales. DB schemes – which guarantee retirees a set income on their retirement – have traditionally been buyers of long-term government debt, as well as index-linked gilts which keep pace with inflation.
However, most of these schemes have closed to new members as the pension industry shifts to products linked to savings and stock market performance.
Responsibility for these funds is taken over by insurers once a fund reaches a stage known as “buyout”. However, different regulations in the insurance industry means they do not need as many gilts and many are likely to sell. As a result, the Government will be issuing new debt at a time when there’s a glut of gilts on the market.
Analysis presented to the Bank and DMO suggested that DB schemes were likely to stop being net buyers of bonds within the next few years as a result.
The Bank of England is also offloading long-dated debt at a pace of around £2bn each quarter, adding yet more supply.
Demand for UK debt has been strong in recent months, with a recent auction almost three times oversubscribed. City sources said that while demand for long-dated debt may continue to be strong in the coming year as pension funds continue to de-risk, the UK faced a debt crunch later as that demand dried up.
Imogen Bachra, a senior rates strategist at NatWest, said the DMO was likely to be “very careful” to avoid the risk of a failed auction but added that she “shared concerns” about waning demand.
Ms Bachra said: “I think the risk is more that the long end remains quite cheap because all of that supply is coming against the backdrop of changed demand at the long end.
“The DMO has long been able to rely on pension funds to absorb all of its issuance essentially. I think that’s different now.”
The DMO declined to comment.