Gilts: Testing market appetite for UK Government debt

4 min read 18 Jan 23

The Gilt market is bigger than it has ever been – and more volatile than it has been in decades, which throws up interesting and exciting opportunities.

The size of the Gilt market, as measured by the amount of nominal outstanding Gilts, has been expanding constantly for the last 15 years. After expanding rapidly following the financial crisis, the pace of increase had slowed to a trickle until Covid struck in 2020. However, since then it has expanded at pace to fund the economic support measures that were put in place during lockdown.

Gilt issuance will most likely be substantial over the next 2 to 3 years as measures like the energy price guarantee have to be financed as tax receipts slow/fall as the economy enters recession. The chart below shows the amount of outstanding nominal Gilts.

Unwinding the balance sheet

Initially the explosion in issuance did not prevent a problem for the Gilt market because the Bank of England (BoE) bought most of it. However, they have now begun the process of reducing their balance sheet and a further expansion in the size of the national debt will be much more of a challenge to fund.

The next chart shows how the stock of outstanding nominal Gilts net of APF (asset purchase facility) holdings has not actually increased much over the past 3 years. Hence it has not been hard to finance. The net stock is the Gilt stock not owned by the BoE.

Testing market appetite

Now we look at what is likely to happen to the net outstanding stock of Gilts over the next 3 years.  There are two key forces at work here, and for the first time they are both pushing in the same direction. Firstly, the Government is likely to run a sizeable deficit, which will require more Gilts to be issued. Secondly, the BoE is now running down its Gilt holdings and will be allowing maturities to roll off, which will have to be refinanced with new Gilt issuance, and it is actively selling Gilts as well.

So, the total outstanding stock of Gilts will grow, and more of it will be owned by investors other than the  BoE. The chart estimates how the net stock will rise based on the Office for Budget Responsibility’s (OBR) forecasts for the Government deficit and the pace at which the BoE intends to run down its holdings. The increase in net Gilts outstanding is far in excess of anything we have seen so far and will test the market appetite for UK Government debt.


This will clearly present a challenge for the market to absorb. There will undoubtedly be periods of volatility along the way. We have seen a dramatic increase in the magnitude of market movements in recent months.

The chart below shows the rolling 6-month standard deviations of daily market moves. The blue line is for the overall market level (10-year Gilt yields) and the orange line shows the same but for the slope of the yield curve between the 10-year and the 30-year. The current levels are possibly an exaggeration of what may be expected in the coming years because the late September/early October period may not be repeated. However even a halving from recent weeks will still see volatility far higher than the average over the last 10 years.

Will Gilt Yields Rise Dramatically Over the Next Few Years?

Not necessarily. The chart showing the big rise in net outstanding stock of Gilts is certainly an alarming picture. It strongly suggests that all else being equal, Gilt yields will most likely rise dramatically to absorb all the extra supply. However, we would make some key observations before jumping to such a conclusion.

  1. The chart is a forecast and therefore contains assumptions, firstly, in terms of expected Government borrowing. In the past the OBR has tended to overestimate borrowing requirements, so it’s quite possible that ultimately the Government may not need to borrow quite as much as feared. Secondly, we assume that the Bank of England reduces its Gilt holdings at the pace it is currently indicating. If Gilt yields started to rise dramatically, this is unlikely to be the case. A gradual grind to yields on the 5% to 6% range over the next 2 years may be tolerated. But if the pace was deemed to be too rapid, the BoE would most likely halt Gilt sales.

  2. 2022 saw rising Gilt yields. If long Gilt yields were still around 1%, then a large sell off would be almost certain. However, 30-year Gilts now yield 3.5%. There will be investors with unhedged liabilities that may now find the Gilt market a much more attractive place to invest.

  3. Not all Gilt issuance is equal. Over the past decade, UK Gilt issuance has had a much longer average maturity and duration than issuance from other countries. This was due to very large demand form institutions looking to hedge long dated liabilities. If this demand is no longer adequate to absorb such a large proportion of issuance being long dated, then the Debt Management Office (DMO) could make the UK issuance profile look more like the US, for example, and issue a higher proportion in short and medium dated bonds. This would put less pressure on the Gilt market than simply pro rating the higher issuance.

  4. The economic fundamentals are highly relevant to Gilt pricing. The big focus in recent months has been on high inflation. If a protracted recession becomes the central issue, then that would be more supportive for Gilt pricing.

All things considered, the Gilt market will be subjected to some big challenges over the next couple of years. The key driving narrative in the markets will probably rotate several times. It is not a certainty that this will result in much higher yields, but it may likely result in elevated volatility for the foreseeable future. 

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.

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