Article 2.3 Europe on track to sell record amounts of inflation-linked debt
By Elaine Moore
Financial Times June 12, 2014
Europe is on course to sell more government debt linked to inflation than ever before, in spite of the looming risk of deflation across the region.
So far this year the supply of bonds tied to eurozone inflation has reached ˆ52.9bn, more than two-thirds of the entire supply of inflation-linked bonds in 2013 and close to the full year’s supply in 2012.On Wednesday, France issued its largest inflation-linked bond since the financial crisis began, selling ˆ3.5bn of 15-year debt. France is the exception within inflation-linked bond issuers because it sells bonds tied to the Europe-wide measure of goods and services as well as one connected to domestic inflation.
Clearly inflation in Europe is extremely low but there is a lot of discussion in the markets about whether it will stay that way and the strength of appetite for inflation-linked bonds shows that not all investors think it will.
The latest inflation-tied debt issuance, which was sold via BNP Paribas, Credit Agricole, HSBC, Nomura and Societe Generale, was notable for the level of interest it drew from UK and domestic investors, said one banker. The bond was priced to yield 20 basis points more than the country's existing inflation-linked note which matures in July 2027.
Inflation-linked bonds have performed poorly for investors in recent years, as global inflation stayed low. However, they are seen as a hedge against the possibility of inflation increases.
‘Demand is high for inflation protection at these levels,' said Jonathan Gibbs, a fund manager at Standard Life Investments. ‘Investors with liabilities linked to inflation, such as pension funds, will be using the opportunity to buy into these bonds.'
In May, Spain issued its first inflation-linked bond, which attracted orders of more than ˆ20bn. Last week Germany added ˆ1bn to its existing inflation-linked bond due to mature in 2023.
FT
Source: Moore, E. (2014) Europe on track to sell record amounts of inflation-linked debt, Financial Times, 12 June.
STRIPS
Some conventional gilts, following issuance by the government and trading on the secondary market, can be stripped. A gilt STRIPS (the letters stand for Separate Trading of Registered Interest and Principal Securities) occurs when the gilt is separated from its coupons and the gilt and its coupons all become zero coupon bonds. Thus a five-year gilt could become eleven separate zero coupon bonds, each with its own ISIN, one for each six-monthly coupon plus the original bond. Twenty-nine gilts have been stripped, resulting in 164 separately traded instruments, and the STRIPS have a value of around £1.8 billion. They are traded at a discount to their redemption value and once stripped can be reconstituted. Only GEMMs can strip gilts.
Table 2.10 UK government STRIPS, some examples
| Gilt name | Redemption date | Clean price (£) | Dirty price (£) | Redemption yield (%) |
| 4% Treasury Principal Strip 07 March 2022 | 07 March 2022 | 82.094598 | 82.094598 | 2.565673 |
| Treasury Coupon Strip 07 March 2022 | 07 March 2022 | 82.094598 | 82.094598 | 2.565673 |
| Treasury Coupon Strip 07 June 2022 | 07 June 2022 | 81.283016 | 81.283016 | 2.610852 |
| 1¾ Treasury Principal Strip 07 September 2022 | 07 September 2022 | 80.473389 | 80.473389 | 2.654188 |
| Treasury Coupon Strip 07 March 2024 | 07 March 2024 | 75.730615 | 75.730615 | 2.874803 |
Source: DMO, 10 June 2014 www.dmo.gov.uk/
The motivation for stripping is that investing institutions might offer a higher price because they can obtain the exact maturity profile and interest rate they are looking for.
The problem with conventional coupon-paying bonds is that long-term buy-and-hold investors have to reinvest the money paid as a coupon, say half way to maturity. What reinvestment interest rate might you get three or four years down the line? It might be more or less than the yield to maturity that you originally bought into, which distorts the overall return received. With STRIPS the rate of return is fixed for the full term because there is only one payout. Table 2.10 shows some of the STRIPS available - details are updated daily on the DMO website. Of course, the clean and the dirty market prices are the same because there are no payments made each six months, therefore no coupon interest is accruing day by day.Islamic UK government bonds
The UK government is determined to make London a world centre for the issuance of bonds that comply with sharia law (see Chapter 7 for more detail). In 2014 it pioneered western government sovereign borrowing in sukuk - see Article 2.4. It will not pay interest because this is forbidden under sharia, but it will pay annual profit.