Britannia Radio

The Bank of England’s gilty secret: betting on inflation?

Posted by Sam Jones on Mar 31 12:23.

The Bank of England has a rather smart set of pension fund managers. Take the below snippets, from the BoE employees pension fund report, 2008.

Major changes during the Scheme year
2007-08 was a year of major structural change for the Fund:

…

- at the request of the Bank, and after careful consideration, the Trustee made a fundamental change in investment strategy, as a result of which the Fund’s assets are now predominantly invested in gilt-edged securities;

In fact, that conservative gilt reorientation saw the fund up considerably this year, in a period in which other pension funds have been decimated.

Except, go further into the report and a curiosity arises (emphasis ours):

The revised strategy is reflected in a new Statement of Investment Principles adopted during the year, a copy of which is available on request. In accordance with the new Statement of Principles the Fund’s former holdings of quoted equities and overseas equities were liquidated during the year and the proceeds reinvested in gilts of appropriate maturities, mostly index-linked in line with the liabilities. Other less liquid investments are also being progressively sold and the proceeds similarly reinvested.

Indeed, whereas in 2007, index-linked gilts comprised 25 per cent of the BoE pension fund portfolio, in 2008, they made up just over 70 per cent of it.

Index-linked gilts, of course, being securities designed to withstand inflationary conditions.  A pension pot position not exactly in line with the bank’s very strong deflationary pronouncements of late, and indeed, the inflationary practice of quantitative easing, or printing money, as its detractors better know it.

Guido Fawkes has the story, via Peter Oborne at the Mail.

Writes Oborne:

Looking back, this was a brilliantly farsighted decision because shares have since fallen in value by almost 50 per cent. It seems clear the the Bank of England fund managers understood the nature of the looming economic crisis well before anyone else. 

And adds Guido:

… if deflation is (as the political elite and their client media commentators claim) the big threat, why is the Bank of England’s pension fund betting 3/5 of the £2.2 billion pot on hedging against inflation?

Intriguing.

Though we would point out that back in 2008, when the Bank of England instructed the fund manager to make this decision, the BoE’s inflation expectations weren’t quite as deflationary as they have since become (mid-2008, forget not, saw the highest oil price ever).

The below graph from the February 2008 inflation report:

Indeed, the bank’s position in early 2008 seems to be: ‘we don’t really have a clue’. Which might more rationally, less conspiratorially, explain the index-linked gilt investment decision.It’s not strictly fair to say index-linked gilts are a bet on inflation. Obviously being linked to RPI, they are, but because they are also bonds - government guaranteed ones at that - they’re a bet on deflation too.

This entry was posted by Sam Jones on Tuesday, March 31st, 2009 at 12:23 and is filed under Capital markets. Tagged with bank of england, gilts, inflation, qe, Rpi.