Nick Dunbar, Senior Consultant at Vedanta Hedging writes in the Financial Times about the increased risk and cost for governments as inflation becomes more persistent across developed nations. This is one of the main reasons why Chancellor Jeremy Hunt had to be so tough last week – our interest bill is now nearly 5% of GDP, similar to what happened after World War 2!
Governments issued increasing amounts of inflation-linked bonds which was attractive for them whilst inflation was low. However given the surge in inflation in recent months, the cost to issuers has risen significantly. The UK is a perfect example of this which pioneered this form of bonds, known as “linkers”, in the 1980s.
The UK’s Office for National Statistics has flagged the rising cost of linkers, noting that index-linked gilts accounted for £55bn of the UK’s £92bn interest payment bill in the year to August — an outsized contribution considering that they are 25 per cent of outstanding gilts.
Meanwhile, the US is set to pay $150bn in interest this year on its portfolio of Treasury inflation-protected securities, half the amount it pays on nominal Treasury bonds, according to the US Treasury website. This is even more remarkable, given that just 9 per cent of US government bonds are Tips.
These costs are set to rise further, based on market inflation expectations. We estimate that for the £2tn of UK gilts, annual interest costs are set to rise to £110bn a year in 2024, and stay at around £100bn annually for a decade. That’s double UK government forecasts and doesn’t take into account any additional borrowing.
Please see below for the full article in the Financial Times:A shock looms for governments over inflation-linked bonds _ Financial Times