LONDON, May 13 (Reuters) - The Bank of England should be alert to the risk that future interest rate hikes could roil Britain's government bond market because of the growing role of hedge funds and overseas investors, policymaker Catherine Mann said on Wednesday.
Such an outcome could tighten financial conditions in Britain's economy by more than the BoE intends, Mann said, as a more price-sensitive investor base in the gilt market amplifies the impact of any rate rise.
"Given fragilities and economic
uncertainties in the domestic and global financial markets, investor sentiment can shift abruptly," Mann said in a speech to be delivered to the London School of Economics.
"A tighter monetary policy stance could trigger volatility as the new actors unwind positions, potentially leading to tighter domestic financial conditions than intended," she added, saying the BoE would need to be alert to these risks.
On Tuesday, as Prime Minister Keir Starmer faced intense pressure to resign following his Labour Party's defeat in local and regional elections last week, British 30-year bond yields hit their highest since 1998 and 10-year borrowing costs rose to their highest since 2008.
Yields fell on Wednesday but remained close to these highs.
WARNING OF PERSISTENT RISK PREMIUM
The shift away from traditional gilt holders like pension funds could, in calmer times, help to reduce government borrowing costs, as hedge funds and overseas buyers need only a modest rise in yields to be drawn into purchasing gilts, Mann said.
But these investors are also much more likely to exit quickly when market conditions deteriorate, amplifying volatility in yields and potentially embedding a persistent risk premium in British government debt, Mann said.
She added that Britain's persistent current account deficit and reliance on overseas financing reinforced those risks, especially if a domestic economic or political shock triggered a slide in sterling at the same time.
Regarded as one of the most hawkish members of the Monetary Policy Committee, Mann's comments suggest potential brittleness in the gilt market was now playing on her mind as she weighs up the case for an interest rate hike.
Financial markets currently expect two or three quarter-point rate hikes by the BoE before the end of this year, although a slim majority of economists polled by Reuters this week expects rates to stay unchanged.
Last month Mann said she expected interest rates to rise if inflation outturns and expectations continued to climb as a result of higher energy costs following the closure of the Strait of Hormuz.
Overseas ownership of British government debt averaged a record 33% of the total amount in issue in the year to the third quarter of 2025, according to official records dating back to 1987.
(Reporting by Andy Bruce and David Milliken; Editing by Emelia Sithole-Matarise)
