Foreign governments and state-backed agencies are taking advantage of sterling’s historic cheapness by hiking the amount of debt they sell in the UK currency. But the boom is unlikely to last much longer.
Last month government and agency borrowers raised £9.2bn in fresh sterling debt, the highest monthly total in four and a half years and the busiest start to the year for five years, according to figures from data provider Refinitiv. The sterling market is “absolutely on fire”, said one deals banker.
The European Investment Bank, German state-owned lender KFW, the Asian Development Bank, Dutch public sector bank BNG and the government-owned Swedish Export Credit Corporation all piled in this year. They were followed by the Council of Europe Development Bank, FMS Wertmanagement (Germany’s “bad bank”) and the Inter-American Development Bank, among others.
Although sterling has retrenched somewhat from its 2017 lows and is trading around $1.30 to the US dollar, it is still 10 per cent lower than its pre-referendum level. Meanwhile gilt yields, the reference point for any debt denominated in sterling, are in a sweet spot.
The economic uncertainties of Brexit are keeping UK yields subdued, as investors are not expecting a rate rise from the Bank of England anytime soon. Yet yields remain well above those of other key economies including the eurozone, Switzerland and Japan, which is a lure for investors in those countries.
For issuers selling debt in a variety of currencies, that offers an opportunity. By denominating their debt in sterling, governments and multilateral institutions can offer investors a higher rate of return. Swap rates, too, remain low, increasing the lure of sterling assets.
Most governments and agencies front-load their funding at the start of each year, so in the past month these factors have combined to create “a perfect storm for investors and issuers”, says Peter Chatwell, head of rates strategy at Mizuho. But the trend could be shortlived.
With political turmoil in the UK escalating as the country’s departure from the EU approaches, opportunities to sell debt are likely to wane. And in the longer term the EIB, one of the biggest and most frequent foreign sterling issuers, is likely to cut back after Brexit.
Although the EIB can be expected to continue to tap the sterling market when the price is right, the UK will cease to be a member. That means the EIB’s sterling liabilities will decrease, removing a reason to issue in the currency.
A decline in issuance could hit liquidity and that may feed through into pricing. Investors generally demand a higher risk premium in smaller, less liquid markets. In the coming years, the UK’s debt markets could become a quieter — and perhaps more expensive — place to play.
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