``The Bank is obviously determined to make some more progress,'' said Peter Clarke, head of gilts sales at Kleinwort Benson. Gilts market-makers believe the Treasury has been pushing for more index-linked issues for some time.
The authorities' desire to increase the share of government borrowing funded by the index-linked stocks - whose final repayment value is linked to inflation - was signalled by Ian Plenderleith, an executive director of the Bank, in a speech in June. He said adaptations to the index-linked market would be considered as part of the broader programme of structural reform of the gilts market.
There would be two practical advantages to funding more of the public- sector deficit with index-linked stocks. One is that it would create an incentive for future governments not to let inflation rise, because this would raise the cost of financing its borrowing. The other is that index- linked gilts pay a lower coupon than conventional gilts, so there is a saving on annual interest payments.
In the long run there is no cost saving as the final repayment of principal is higher to take account of inflation.
Institutional investors are expected to buy more index-linked gilts during the next few years. The Goode Report on pensions recommended that funds should increase their holdings of fixed-interest assets relative to equities by 1999. And index-linked stocks are likely to suit mature funds, which are paying out amounts that rise with inflation and which are not receiving new contributions.
Many investors complain the market is illiquid. However, in the past year the Bank of England has stepped up the help it gives gilt market- makers by buying and selling the stocks when it will improve liquidity.
For market-makers the main problem is that they cannot easily hedge transactions in index-linked stocks. In the case of conventional gilts they can offset their positions by buying gilt futures. There are no futures for the index- linked variety, however.Reuse content