By Andy Bruce
LONDON (Reuters) – On top of the risk that Britain will leave the European Union in March without a transition deal, its government faces an extra headache next year: the biggest debt-refinancing bill in recent history.
Almost 100 billion pounds of government bonds will mature in the next fiscal year, when Britain needs to repay a host of bonds issued after the financial crisis a decade ago.
In normal times, that would not be an issue. But with Britain due to leave the EU in less than four months, possibly with no transition agreement, it creates fresh doubt in an era of uncertainty for British assets that has few precedents.
Prime Minister Theresa May’s Brexit plan has been agreed with the EU but faces deep opposition in parliament, where it faces a vote on Dec. 11, raising the risk of no-deal Brexit economic shock.
The volume of redemptions in the 2019/20 fiscal year — which starts in April — is likely to equate to 4.5 percent of nominal gross domestic product, the biggest share since records started in the mid-1990s, before declining in future years.
“It’s a huge refinancing exercise. It’s going to be quite a big test,” Marc Ostwald, strategist at ADM Investor Services, said.
The Debt Management Office (DMO) declined to comment.
Gilts are viewed as safe assets, with around 1.1 trillion pounds in circulation besides those accumulated by the Bank of England to power its post-crisis stimulus for the economy.
The average maturity of gilts is around 15 years, more than double the euro zone average, spreading the bulk of Britain’s refinancing risk over many years into the future.
But the lack of clarity around the terms of Brexit, due on March 29, comes at an inopportune time. Two bonds, each with more than 36 billion pounds in issue, are due to mature either side of Brexit: first a 4.5 percent gilt on March 7 followed by a 1.75 percent gilt on July 22.
Investors might seek new homes for the money flowing back to them from redeemed British government bonds rather than reinvest in gilts, depending on how Brexit turns out.
“I know a lot of people would say, well that doesn’t matter, we get the money redeemed and we just plough it back in the market. But are you going to want to?” Ostwald said.
For a graphic on UK’s refinancing hump, see – https://tmsnrt.rs/2RCFuF6
KINDNESS OF STRANGERS
A 20-year gilt auction last month brought a hint of nervousness. The DMO had to accept low bids to an extent not seen since the height of the financial crisis.
Foreign demand could be an issue in the event of a so-called hard Brexit.
After the 2016 Brexit referendum, overseas demand for gilts rose sharply, in part because central banks and sovereign wealth funds wanted to top up their sterling portfolios battered by the pound’s plunge.
But a no-deal Brexit could be different. It would quickly affect Britain’s economy, from trade links to regulation and foreign investment, in a way the referendum result did not.
About 27 percent of gilts are held overseas. That is a smaller share than in many other European countries, but it is a reminder of how reliant Britain is on the “kindness of strangers”, as BoE Governor Mark Carney put it.
Most investors still think the most likely possibility is that Britain leaves the EU with a transition deal.
Mike Amey, sterling portfolio manager at bond giant Pacific Investment Management Co., said in that case the BoE would probably continue raising interest rates, and sooner than investors expect.
“Two hikes seems on the lower side to us, if you get a cooperative Brexit,” he said.
Other investors aren’t so sure. Alberto Gallo, portfolio manager for the Algebris Macro Credit Fund at Algebris Investments, said the BoE has largely missed its chance and will probably only raise rates once in the next 18 months.
Helping gilts is the fact that the BoE will be a big player in the market next year.
It owns around 40 percent of the volume of gilts maturing in 2019, and its policy is to re-invest redemptions into the market, at least until interest rates reach around 1.5 percent — double their current level.
But foreign investors might hold off on re-investing, particularly if sterling is volatile, ADM’s Ostwald said.
An active sell-off by foreign investors of existing holdings of bonds, as Italy saw in recent months, remains unlikely, given that Britain’s solvency is not in doubt.
“A large amount of redemptions where the money isn’t flowing back into the gilt market from those foreign investors is probably the bigger challenge,” Ostwald said.
In that case, gilt yields could rise, putting extra strain on borrowers in what would already be a difficult economic environment and adding to government borrowing costs.
“Obviously that is not as bad as having active sellers. But nevertheless it means there needs to be more money found from domestic buyers,” Ostwald said.
(Additional reporting by Abhinav Ramnarayan, Saikat Chatterjee; editing by William Schomberg, Larry King)