Gilts dealers under attack by investors

TWO large investors plan to complain to the Bank of England about the failure of market makers to quote prices in index-linked gilts on wobbly Wednesday, the day sterling left the exchange rate mechanism.

Dealers say only four out of 19 gilts market-makers were making markets on 16 September, when the Government announced an increase in interest rates to 15 per cent but later dropped the plan.

Fifteen firms were breaking the rules that require all gilt market- makers to make markets - quote prices at which they are prepared to buy and sell stock - in the full range of gilts, which are units of government debt. Market-makers are not allowed to pick and choose.

Investors and rival dealers said not all market-makers were fulfilling their duties.

The complaints are similar to those made about equity market- makers at the time of the October 1987 crash.

Investors said then that some firms were not answering their telephones.

But a spokeswoman for the Bank of England said it had not received any complaints about gilts.

'As far as we are concerned markets were made as we expect them to be.'

Large investors who wanted to buy index-linked gilts because they believed the pound was likely to be devalued and that inflation would rise as a result found it difficult to buy as much stock as they wanted.

Index-linked gilts offer income and capital growth in line with the retail price index.

The price of a Treasury 2.5 per cent index-linked gilt due to be repaid at the end of the decade has risen by 9.6 per cent since sterling left the ERM.

One investor said he had spent about pounds 200m on index-linked stocks on Wednesday but it took longer and cost more than he expected to acquire stock.

Investors and dealers agree that spreads - the difference between the prices at which market-makers are prepared to buy and sell stocks - widened, making purchases less attractive.

One dealer said spreads changed from less than 0.2p to more than 0.5p in the week sterling was devalued. Spreads often become wider in illiquid markets where the volume of dealing is low.

Another firm said the Bank of England's behaviour 'was not especially helpful'. Dealers criticised the Bank for issuing a new stock rather than increasing the issue of an existing stock. This would have improved market liquidity.

The volume of trading in index- linked gilts is far less than in traditional gilts and spreads are relatively wide.

Dealers said most market making firms held low volumes of index-linked stock, making them cautious about making prices, especially when they thought prices might move suddenly.