TYABY Turkiye IS Bankasi AS C (PK)

By Jon Sindreu and Christopher Whittall 

Prices of U.K. corporate bonds have soared in the last month on investor bets that the Bank of England will start snapping them up as part of a stimulus plan. But some fret that the central bank's impact on such a small market will be hard to predict, if such an intervention happens at all.

Yields on sterling-denominated corporate bonds have steadily moved lower since the U.K. referendum on June 23, despite widespread fears that the decision to leave the European Union will hurt British companies. Yields fall as bond prices rise.

While most of this drop is due to expectations that the central bank will cut interest rates, the spread between yields on bonds of nonfinancial companies and safe cash recently came close to a one-year low, according to figures by research firm Markit Ltd., reversing a post-Brexit surge.

Such credit spreads are supposed to reflect how likely a company is to default. But many analysts believe spreads have narrowed so sharply on speculation that the Bank of England will start buying these bonds.

Several major banks have told clients they expect BOE officials to announce such a program at their policy meeting Thursday, alongside an increase in sovereign-bond purchases and a cut in interest rates to 0.25%.

But some investors remain unconvinced.

Expectations of renewed purchases of government bonds, of which the BOE still holds GBP375 billion ($501 billion), have driven Mike Riddell, a portfolio manager at Allianz Global Investors, to buy more of them. By contrast, he believes sterling-denominated corporate debt has become too expensive and has started selling it.

"Valuations are starting to look pretty stretched," said Mr. Riddell, who thinks the central bank is unlikely to announce a corporate-bond-buying program on Thursday.

The yield on the Barclays Sterling Aggregate: Corporate index, which has an average maturity of more than 12 years, is around 2.5%, down from 3.1% prior to the Brexit vote.

Since June, the European Central Bank has been buying around EUR9 billion ($10 billion) of euro-denominated corporate bonds a month, on top of roughly EUR70 billion worth of government and agency bonds. Effects have been particularly noticeable in corporate-bond markets, because there are far fewer buyers and sellers, making prices more prone to swing around when a massive player enters the market.

The sterling corporate market is even smaller, because many large British corporations prefer to borrow in euros and dollars. While some big companies have very recently added to the supply of sterling bonds -- Vodafone Group PLC borrowed GBP1 billion Monday -- issuance has fallen in the last few years.

A shallow market will make life difficult for policy makers. According to research by Capital Economics, the total universe of bonds the central bank could buy is about GBP130 billion, compared with the roughly EUR700 billion market the ECB can tap. This would point to purchases of less than GBP1 billion a month.

Earlier rules set up by officials suggest they could even be much smaller in size. Between 2009 and 2013, the BOE made a short-lived attempt to buy corporate bonds, but only purchased a total of GBP2 billion, all in investment-grade, nonfinancial-company debt. It also bought roughly GBP1.5 billion of commercial paper, short-term debt instruments issued by companies.

These purchases, however, were carried out to prevent the markets from freezing after the financial crisis. Now, analysts and investors are worried that such a program would be too small to have any effect on the broader economy -- but still might be large enough to choke liquidity in the corporate-bond market.

"Distorting conditions further in sterling bond markets is not really going to help the overall business profile," said Suzanne Keane, co-head of credit research at Pioneer Investments, who added that her firm will only buy sterling-denominated bonds if they offer a decent amount of extra yield versus comparable securities in more liquid currencies like euros.

"I don't think it would necessarily be a good thing for U.K. corporates, " she said.

Write to Jon Sindreu at jon.sindreu@wsj.com and Christopher Whittall at christopher.whittall@wsj.com

(END) Dow Jones Newswires

August 03, 2016 16:30 ET (20:30 GMT)

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