The UK Treasury says it will not issue long-dated interest rate call options, defying a specific recommendation of the Miles Review, a report on the mortgage market published just prior to the 2004 budget.The revelation was made in the Treasury’s Debt Management Policy report, released today. It said the motivation for the recommendation was that the existence of a liquid market in longer-term interest rate derivatives – specifically longer-term interest rate call options – could contribute to improving the efficiency of the mortgage market.
A lack of natural writers of the options means that currently, a market for them doesn’t exist. However, the review said that the government may have the characteristics of such a writer and if it were to start issuing them, it would be helping to complete financial markets.
The report, however, said that although there may be a case for issuing the options, it would need to be consistent with the objective of minimising long-term cost subject to risk. It would also need to be made clear that issuing the options would substantially benefit markets. The report said that it is unclear that there is a significant unmet demand for longer-dated options.
The report stated that although there may be some benefits from issuing the option, “a substantial degree of uncertainty remains over the balance of advantage to the government”.
Detailed analysis of the decision will be available when the Debt Management Office publishes its annual review this summer.
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