Hedge fund trading is contributing to upward pressure on UK gilt repo rates, according to a report by Bloomberg citing comments made by Victoria Saporta, the Bank of England’s Executive Director for Markets, at the ECB Money Market Conference in Frankfurt.
Saporta believes that increased trading opportunities for non-bank investors, including hedge funds, have raised demand for funding in the gilt repo market. These trades, which involve borrowing cash against government bond collateral, have become more prevalent as interest rates rise and government bond issuance grows.
“The pursuit of these opportunities has led to an increased demand for funding from non-banks to finance trades involving long positions in government bond collateral,” said Saporta. “As repo markets are a key source of funding for sterling activity, this has likely contributed to higher repo rates.”
The BOE official cautioned that market volatility and higher repo costs, such as those seen last week, are expected during the transition away from pandemic-era liquidity. Factors include the rolling off of BOE cheap loan programs, tensions around Canadian year-end, and broader shifts in central bank liquidity provision.
Saporta noted that the central bank is now providing cash primarily through repo facilities as it reduces its balance sheet, a move designed to wean markets off quantitative easing. The BoE is currently shrinking its gilt holdings at a pace of £70bn per year, while approaching its preferred minimum reserves range.
