The UK has sold bonds with a negative yield for the first time, with a fall in inflation heaping further pressure on policymakers to take new action to prop up the economy.
The sale effectively means that investors are paying for the privilege of lending to the UK government, reflecting growing investor expectations that the Bank of England may need to take additional steps to push inflation back to its 2 per cent target.
The BoE has so far resisted cutting its main interest rate below zero but other central banks, such as the European Central Bank and Bank of Japan had already pushed their rates into negative territory even before the Covid-19 crisis.
The UK sold £3.8bn of three-year gilts at a yield of minus 0.003 per cent, according to the Debt Management Office. The slightly negative yield suggests investors who hold the debt to maturity will get back less than they paid, when accounting for regular interest payments and the return of principal.
The UK sold a one-month bill at a negative yield in 2016, but this represents the first time it has sold a conventional longer term bond at yield below zero.
Data released on Wednesday showed annual UK consumer price inflation nearly halved to 0.8 per cent last month — the lowest level in almost four years. Much of the decline was due to a plunge in the price of petrol, but some economists have warned the shock to demand caused by lockdowns could cause a wider disinflationary trend.
Adrian Paul, economist at Goldman Sachs, said he expected the BoE to increase its bond purchase programme by £100bn next month “against the backdrop of a protracted period of below-target inflation”.
“With inflation now more than 1 percentage point below target, the governor of the Bank of England will . . . have to write a letter to the Chancellor explaining why inflation is so far below target and what he intends to do about it,” said Melanie Baker, senior economist at Royal London Asset Management. “The next step we expect to see is more asset purchases.”
The UK drew orders of £8.1bn in Wednesday’s auction, 2.15-times the amount the DMO was looking to sell. The robust demand underscores the appeal of gilts, long considered to be a haven due to the UK’s strong creditworthiness. It also suggests any fears over the large increase in borrowing the UK has undertaken due to the Covid-19 pandemic has not yet weighed on investor appetite for the debt.
The auction comes during the growing debate into whether the BoE will need to reduce its main interest rate from its already historic low into negative territory, as policymakers attempt to bring inflation back towards the 2 per cent target and shield the economy from coronavirus-induced ructions.
Moyeen Islam, rates strategist at Barclays, said the auction was a “symbolic hurdle”.
“Given recent comments from monetary policy committee members, the question of negative policy rates is far from settled,” he said.
Other central banks that have already used negative rates have faced criticism, especially from banks since it weighs heavily on the profitability of their traditional lending operations.
“I can’t think of an economy where negative rates are a worse idea than the UK,” Kit Juckes, a strategist at Société Générale, said.
“The economic benefits are dubious but the power of a cocktail of negative rates and massive quantitative easing to weaken the currency seems clear and if the pound falls enough, it will make QE harder,” he said.
Additional reporting by Katie Martin in London