The UK Debt Management Office, the executive agency responsible for carrying out the UK government’s debt management, has sold government bonds, commonly known as gilts, with negative yields for the first time in its history.

The Bank of England is considering moving its key policy rate below zero.

On Wednesday 20 May 2020, £3.8bn worth of on-the-run three-year gilts sold at auction with a -0.003% yield, effectively meaning investors are paying to lend the UK government money.

The pricing of the issuance is a manifestation of the disruption Covid-19 has wrought upon the global economy and financial markets, with accompanying investment portfolio asset allocation shifts being reflected in ETF markets.

The UK Treasury has previously issued short-term Treasury bills (debt securities with maturities below one-year) at negative interest, and off-the-run gilts have recently been trading with negative yields.

However, yesterday’s sale marks the first time that the UK has auctioned off new longer-maturity bonds in negative territory.

Other countries currently offering government bonds with negative yields include Germany, Switzerland, and Japan.

With global growth grinding to a halt in response to lockdown orders, central banks around the world slashed their key interest rates earlier in the year in a bid to promote lending and stimulate their economies. Following a special meeting on 19 March, the Bank of England cut its main policy rate to an all-time low of 0.1% and announced plans to increase its holdings of UK government and corporate bonds by £200 billion.

The move resulted in an immediate drop in UK government bond yields which have continued to be driven lower by sharp re-adjustments in inflation expectation (inflation hit a four-year low of 0.8% in April, well below its 2% target) as well as continued demand for safe-haven assets amid ongoing volatility.

The £1.7bn iShares Core UK Gilts UCITS ETF (IGLT LN) has gained 8.2% since bottoming out on 18 March (as of 19 May 2020), while the £930 million iShares £ Index-Linked Gilts UCITS ETF (INXG LN) has rebounded 22.4% over the same period after inflation-linked gilts were strongly sold off during the liquidity crisis in the weeks prior. Bond prices move inversely to interest rates.

The lower expectations for inflation have caused enthusiasm for inflation-linked gilts to wane with £65m net outflows recorded from INXG since the beginning of March. Net inflows for IGLT are approximately flat over the same period after strong outflows in March were followed by inflows in April and May month-to-date.

Despite interest rates hovering at zero, the risk of the pandemic causing a protracted recession is putting pressure on the Bank of England to move its key rate into negative territory.

There has been much debate about the effectiveness of negative interest rates with critics arguing that they undermine the profitability of banks by charging institutions for depositing reserves.

Bank of England governor Andrew Bailey, who took over the reins from Mark Carney in March, initially indicated he was opposed to negative rates but appears to be changing course after recent comments stating it would be “foolish” to rule them out.

The Bank of Japan and European Central Bank have already adopted negative interest rates to stimulate borrowing, while the Federal Reserve has so far resisted calls from US President Donald Trump to follow suit.

The adoption of negative interest rate policies, especially by the Federal Reserve, is likely to lead to further inflows into gold ETCs as gold bullion’s relative value compared to income-producing securities becomes more attractive. Investors have been increasing their allocation to the yellow metal in recent months, seeking to bolster their portfolios against future volatility and protect against potential inflation caused massive monetary stimulus.

Europe’s largest gold ETCs, the $12.2bn iShares Physical Gold ETC (IGLN LN) (see chart below) and $11.4bn Invesco Physical Gold ETC (SGLD LN), have each gathered $2.7bn in net inflows since the beginning of March.