UK looking at 100-year bonds to lock in low rates

March 14, 2012 - 10:45 AM

LONDON (AP) — Britain is looking at ways of taking advantage of the country's super-low borrowing costs by considering the launch of bonds that would be repaid over 100 years, a senior Treasury official said Wednesday.

Robert Stheeman, chief executive of the Debt Management Office, said a formal consultation with potential buyers was likely to begin in the new financial year, which starts in April. However, he said the final decision will rest with ministers, notably Treasury chief George Osborne, who delivers his annual budget statement next week.

"The whole purpose of us consulting with the market is to establish whether or not there might be a demand for such instruments, how strong the demand would be and how cost-effective it would be," he said in a telephone interview. "Because we are consulting with the market, that doesn't mean a decision has been made."

At the moment, the U.K. and other countries, sell off their debt in the form of bonds. These bonds pay interest before being paid back after a set time — an average of 14 years in the case of Britain, double the average of the world's seven leading industrial economies. The longest recent issue is for 50 years.

If the U.K. issues perpetual bonds, it would just pay the interest for a very long time up until the government decides to redeem them, which theoretically could be never.

The long-term bonds would include an option for the government to pay off the debt; the bonds are reviewed periodically to assess whether it would be prudent to do so, Stheeman said.

Britain is currently enjoying super-low interest rates in the markets after the Bank of England slashed its main interest rate to a record low of 0.5 percent three years ago and enacted a monetary stimulus program designed to keep a lid on borrowing rates.

Analysts say that the rate that could apply on a 100-year bond won't be too far off 3.5 percent, a little higher than what currently exists for Britain's long-term bond portfolio. The current rate on the country's benchmark ten-year bond is around 2.20 percent, in line with the equivalent U.S. Treasury bond.

Even though Britain's deepest recession since World War II is officially over, the British economy is struggling to get any momentum as unemployment remains near a 17-year high and the government pursues a debt-reduction program designed to get the public finances back into shape.

Mark Ostwald, analyst at Monument Securities, said the government's interest in longer-term debt amounts to an admission that "lowering budget deficits and indeed overall debt burdens in the western world will not be achieved by austerity alone."

A key question in the consultation is likely to center on how much demand there would be from investors. While hedge funds, which want to see returns on a relatively short-term basis, may not be interested, the longer-term bond issues may appeal to pension funds and insurance companies, which seek out financial security over a longer timeframe.

While Britain has a strong market for long-term debt, Stheeman said the consultation would test whether those buyers would want longer maturities.

Britain has eight undated, or perpetual, bonds in its portfolio; the largest is for 1.9 billion pounds issued in 1932 to pay the costs of World War I.

The oldest perpetual bond was issued in 1853, which refinanced debt issued in the 18th century following the crash of the South Sea Bubble investment mania.

Last year, sales of century bonds included $1 billion sold by the government of Mexico, yielding 5.96 percent, and a $350 million issue by the California Institute of Technology at 4.744 percent. Rabobank of the Netherlands sold $350 million in century bonds in 2010 at 5.8 percent.

Vicky Redwood, chief U.K. economist at Capital Economics, said there was an "obvious rationale" for the longer bonds as eventually interest rates will return to more normal historical levels.

She said a simple extrapolation of Britain's debt markets suggests that the rate on a 100 year bond could be as low as 3.5 percent and that on the perpetual bond could be a little under 4 percent — the higher premium exists because investors may not see the bond redeemed.

"Wee think that the U.K.<s ability to even consider issuing a 100 year gilt underlines the degree to which she has managed to maintain market confidence," Redwood said. "In fact, some have suggested that this is no more than a publicity stunt by the Chancellor to show off to the rest of the world how creditworthy the U.K. is."

Whatever the motivation behind the proposal, Britain's not alone in wanting longer-term bonds to act as an insurance policy against changing economic circumstances.

Earlier this week, Greece completed a vital bond swap that is designed to ease its debt burden over the coming decade. One key aspect of the swap was to give holders of Greek bonds longer-dated bonds. The hope is that by giving its debt a longer profile, Greece will not be slave to constantly needing to find new money to pay off investors, giving it more time to enact an ambitious economic reform program alongside its austerity measures.