Thursday, March 26, 2009

British Bond Auction Fails

From Bloomberg:

Bank of England Governor Mervyn King says Gordon Brown should be “cautious” on public spending while the official in charge of U.K. bond sales says the central bank is undermining demand for government debt.

For the first time in almost seven years, the U.K. couldn’t find enough buyers for one of its debt sales when it offered 1.75 billion pounds ($2.55 billion) of bonds yesterday. The yield on 10-year gilts rose after the sale by as much as 20 basis points, or 0.2 percentage point, to 3.53 percent, the highest since March 5.

The failure came a day after King said the government needs to be “cautious about going further in using discretionary measures” to expand government deficits as it tries to pull the economy out of a recession. Robert Stheeman, head of the U.K.’s Debt Management Office, which runs the bond auctions, says it wasn’t able to attract enough bids partly because of the Bank of England’s efforts to lower yields through debt purchases.

“Yields at these levels are not at all attractive,” Stheeman, chief executive officer of the Debt Management Office, said yesterday in an interview in London. “Yields have shifted downward. Why have they shifted down? It’s partly because of the Bank of England’s announcement about quantitative easing.”

Investors say both are to blame for the failed debt sale.

‘Buying or Selling?’

Gilts have “only one buyer and that’s Mervyn King,” said John Anderson, a money manager who oversees about $3 billion in pound-denominated assets at Rensburg Fund Management in London. “You don’t need to look anywhere beyond that. Make your mind up, please, government. Do you want to buy gilts or do you want to sell them? You can’t do both.”


First, I have to admit I have not been keeping up with UK economic events. Right now the US is challenging enough. That being said ...

This is an interesting -- and partially scary situation. Like the US, the British are buying their own debt. But in doing so, they are artificially deflating the price relative to current demand. Because of the level of government spending, investors are concerned about repayment. As a result, the current interest rate provides insufficient risk compensation which led to the latest auction failure.

Some attributed the failure to simple confusion:

Although some experts attributed the failure to confusion in the market, rather than concern over Britain’s solvency, it was highly embarrassing for Mr Brown coming just days before world leaders are due to meet in London for the G20 summit to discuss the economic crisis.


Frankly, the Bloomberg explanation makes more sense: there is now increased risk in purchasing government debt. Investors want to be compensation for this risk. But the government buying debt and thereby keeping it artificially low is keeping private capital out of the market.