Buying Government Bonds

The Bank of England says that a sharp increase in bond offerings by U.K. companies this year has been driven by its policy of quantitative easing, but it's far from clear that its claims are justified. The BOE embarked on quantitative easing - buying government bonds, or gilts, with freshly created money - in March. Its aim was to boost nominal spending in the economy through a variety of channels, although it has left many confused about exactly how the program was supposed to achieve its goal. On Wednesday a member of the central bank's Monetary Policy Committee argued in a speech its impact on the corporate bond market has been a key element of the program's success. David Miles, formerly an economist at Morgan Stanley, argued that by buying GBP151.775 billion of government bonds to date, the BOE had freed up cash that has since been invested in corporate bonds, allowing companies to reduce their reliance on scarce bank credit and maintain their spending at levels that otherwise wouldn't have been possible. But while participants in the corporate bond markets don't necessarily disagree, they say Miles' argument is hard to prove conclusively. After all, demand for corporate credit has also soared in the rest of Europe without central banks there using fresh money to buy bonds. And the pickup in corporate bond sales began in February, before the BOE began its quantitative easing. One fact isn't in dispute - issuance of sterling-denominated, high-grade corporate bonds has soared this year. Other than in the summer holiday months of July and August, issuance has exceeded GBP4 billion every month this year, and topped GBP6 billion twice and GBP7 billion once, according to Dealogic. The highest monthly figure in 2008 was GBP2.819 billion. The relative cost of borrowing has also fallen sharply. Spreads over the benchmark mid-swap rate on the Markit iBoxx Non-Financial Corporate index are 230 basis points tighter than at the beginning of the year. "In the U.K., corporate bond spreads have come down, and issuance has increased," said Gary Jenkins, head of fixed-income research at Evolution Securities in London. "But if you are trying to measure the impact of QE, the same thing has happened in the U.S. and Europe. Unfortunately, this isn't a scientific experiment with a control group." According to Dealogic, bond issuance by non-financial companies in Europe as a whole already exceeds $2 trillion this year, while syndicated loan volumes have dropped to their lowest level since 1994, meaning that it isn't just U.K. borrowers who are selling bonds rather than relying on battered banks to lend them money. Investors have been happy to buy U.K. corporate bond offerings. "There has been huge demand for corporate debt," said Jenkins. "We're still seeing new issues oversubscribed and spreads tighten. As long as we have indications that the economy is stabilizing and interest rates remain low, that will continue." But bankers who find buyers for the bonds aren't convinced QE has made the difference claimed by Miles. "Demand on the new issuance hasn't been affected by quantitative easing," said one syndicate banker. Indeed, the heaviest month for supply of sterling high-grade corporate bonds this year was February, before the QE program began. Issuers sold GBP7.712 billion worth that month. The movement of money into corporate bond funds is still strong. Data from the U.K.'s Investment Management Association this week showed that sterling corporate bond funds were the most popular funds for retail investors for the 10th consecutive month, accounting for 14% of net retail sales by U.K. domiciled-funds, for example. "We've seen tremendous inflows into credit funds, so end investors must have moved out of an asset class to redeploy their money, although that is just as likely to have been equities," said Ben Bennett, credit strategist at Legal & General Investment Management in London. "I don't think anyone was explicitly able to sell gilts to buy corporate bonds in a way that wouldn't have happened without quantitative easing," he said. "One of the points of investing in gilts is that they are liquid and you can sell them when you want to, although investors probably got a better price thanks to the Bank of England buying." That's not to say that QE hasn't helped corporate borrowers. In assessing the impact of the program, credit spreads - the premium that corporate issuers pay over government bonds - are only part of the equation. "Quantitative easing has made a meaningful difference to corporate issuers in keeping government bond yields low," said Allegra Berman, vice chairman and global head of sovereign, supranational and agency debt capital markets at UBS in London. "It would have been prohibitively expensive for corporates to fund themselves if we had seen a combination of high gilt yields and wide credit spreads. QE has kept their all-in funding costs palatable," Berman said. Quantitative easing also helped reassure credit markets that the authorities were tackling the financial crisis, and in particular the collapse of liquidity in the corporate bond market that followed the collapse of Lehman Brothers.