BoE: High hedge fund leverage in gilts risks market spillovers

The Bank of England warned that elevated hedge fund leverage in the UK government bond market, together with strains in the gilt repo market and growing corporate issuance tied to artificial intelligence, could cause simultaneous repricing and spread stress across financial markets.

The warning appears in the BoE’s latest financial stability assessment. The report finds hedge fund leverage in the gilt market remains elevated though broadly stable and that interactions across markets increase the chance that shocks could crystallise at the same time.

The Financial Policy Committee is examining options to strengthen the gilt repo market and plans to publish potential measures in early 2027. The report notes sterling repo activity has expanded, raising non-bank financial institutions’ reliance on funding secured by gilts. Data cited show net cash lending by gilt repo dealers to non-bank financial institutions has roughly doubled since 2023 to about £200 billion.

Ten-year gilt yields have risen to levels last seen around the global financial crisis. The assessment points to heavy government borrowing, higher debt-servicing costs and a wave of corporate debt tied to AI investment as drivers of higher yields.

Renewed conflict in the Middle East has pushed oil, gas and refined-product prices higher. The BoE describes these price rises as a prolonged negative energy supply shock that could keep inflation higher for longer and add pressure to sovereign borrowing costs.

The report says a sharp fall in gilt prices could force leveraged investors to reduce holdings or unwind trades, creating sudden demand for liquidity across multiple markets and increasing volatility. It highlights elevated valuations in parts of the technology sector and rising AI-linked corporate issuance as channels that could amplify stress.

Background notes show a larger role for non-bank financial institutions in sterling money markets and a rise in leverage over the past 18 months. The Financial Policy Committee’s forthcoming measures are intended to improve resilience in the gilt repo market and reduce the risk that a sharp repricing of government bonds spreads into wider financial markets.