According to the Office for Budget Responsibility (OBR), a sharp drop in demand for long-term UK government bonds by pension funds could increase the country’s borrowing costs by at least £20 billion over the next few decades.
The independent government fiscal regulator warns that demand for GILT in gilded tax (DB) pension schemes has been shrinking, a reliable cornerstone once long-term bond ownership – will have a significant impact on public finances.
David Miles, a member of the OBR Budget Responsibility Committee, described the outlook as “worrying”, told MPs that the UK is entering a new era where one of the most reliable buyers of government debt is disappearing.
“You have to find people and tempt them to keep bonds,” Myers said. “That means you have to offer them a better deal.”
OBR estimates that this shift could increase by 0.8 percentage points to increase long-term gold plating yields, increasing the cost of debt services by £22 billion. This figure may be conservative given that public debt (currently 100% of GDP) is expected to rise significantly in the coming decades.
Another OBR committee member, Tom Josephs, responded to the warning: “If debt is rising and you need to attract more buyers, there may be greater financial impact.”
Defined welfare plans traditionally hold gilding to hedge long-term liability, but most people are now closed to new entrants. The pension market has moved towards a determined donation (DC) program that tends to hold fewer government bonds. As a result, OBR expects GILT demand for DB schemes to drop from about £1 trillion (30% of GDP) to 2050 to just 11%, with most of the shift happening before the end of this decade.
This change forced the UK Debt Management Office to transfer to issuing more short-term debt, which is often more expensive and turbulent. It also increases reliance on more “price elastic” buyers such as foreign investors and hedge funds, who usually demand higher yields than domestic pension funds.
“The defined welfare pension funds used to be a source of security demand, and we think demand will be reduced and already exists. This means that the government must attract more price-elastic buyers. This has an impact on the cost of debt.”
Changes in bondholder composition may also increase volatility. Patients, long-term investors are replaced by speculative participants, thereby increasing sensitivity to market changes. The IMF also attracted attention to the fiscal risks associated with structural changes in gilding ownership.
The Bank of England is also under pressure to alleviate its quantitative tightening and bond sales speed, which some economists believe has exacerbated the instability of the gilding market.
With the OBR predicting that the UK may increase GDP by 270% over the next 50 years, ensuring a reliable source of bond demand becomes increasingly important and more expensive.
Unless new long-term investors are found, the government may face higher borrowing costs, just as the financial pressures of health care and defense continue to rise.
