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Market Analysts: The Chancellor isn’t responsible for low gilt yields

10 Feb 2012, by Guest in Economics

Just before Christmas I wrote a slightly too long, slightly too techy and (probably) slightly too boring post on UK bond yields.

The yield on UK government debt is at historical lows. The government argues that this shows the market’s confidence in Osborne’s fiscal strategy and that any retreat from this would lead to higher interest rates choking off the recovery.

As he argued in his Autumn Statement:

Last April, the absence of a credible deficit plan meant our country’s credit rating was on negative outlook and our market interest rates were higher than Italy’s. Eighteen months later and we are the only major western country which has had its credit rating improve.

Italy’s interest rates are now 7.2%. And what are ours? They are less than 2.5%. Yesterday, we were even borrowing money more cheaply than Germany.

Those who would put all that at risk by deliberately adding to our deficit must explain this.

Just a one per cent rise in our market interest rates would add £10 billion to mortgage bills every year. One per cent would mean the average family with a mortgage would have to pay £1,000 more. One per cent would increase the cost of business loans by £7 billion. One per cent would force taxpayers to find an extra £21 billion in debt interest payments, much of it going to our foreign creditors.

In other words, one per cent dwarfs any extra government spending or tax cut funded by borrowing that people propose today.

And that’s the cost of just a one per cent rise. Italy’s rates have gone up by almost 3% in the last year alone.

We will not take this risk with the solvency of the British economy and the security of British families.

Osborne then is pretty clear that his ‘tough action’ is what  has kept yields low.

Interestingly enough  a survey published today by financial information company Bloomberg doesn’t  agree with the Chancellor.

Chancellor of the Exchequer George Osborne’s pledge  to eliminate the budget deficit isn’t the main reason U.K. government-bond  yields are at record lows, say most analysts in a Bloomberg survey.

The Bank of England’s quantitative-easing program,  which has so far purchased a quarter of outstanding gilts, was identified as  the single biggest cause by a third of 27 economists polled. Just over a  quarter said investors fleeing other European bonds were driving U.K. rates  lower, while 22 percent said Osborne’s plan was the main reason

One worth remembering the next time the Chancellor tries to  claim the credit for record low interest rates. Whatever he might want to believe, three quarters of those who actually work in financial markets seem to think he isn’t the main reason for low yields.

5 Responses to Market Analysts: The Chancellor isn’t responsible for low gilt yields

  1. Mr Danger
    Feb 10th 2012, 5:33 pm

    Interest rates reflect inflation expectations, perceived credit risk, and the demand for money (a function of the expected rate of economic growth).

    The inflation and demand for money components don’t much measure the affordability of debt, as higher inflation and higher growth imply higher tax revenues. And the opposite is true, a lower interest rate due to lower inflation expectations and/or lower growth do not increase debt affordability as they imply lower tax collections in the future.

    The component that correctly measures the success or failure of government policy is the risk component. You can separate out the risk component by looking at UK CDS pricing, which exclusively represents the perceived credit risk of the UK, stripped of the other components.

    UK CDS pricing shows lower perceived credit risk for the UK than for Germany, France, the Netherlands, Denmark, and of course all the PIIGS.

    So if you look at the correct measure, bond markets are saying that the Chancellor is getting it right, and as a direct result the UK is benefiting in the form of lower borrowing costs.

  2. Josh
    Feb 10th 2012, 9:13 pm

    Well, our Overlord Chancellor is borrowing more than the much maligned (rightly) Darling plan. So using George’s logic, gilt yields would be lower under Labour than the Tories. The Tories aren’t cutting spending, and I imagine the whizzkids in Wall Street and the Square Mile know this.

  3. It doesn’t add up…
    Feb 11th 2012, 1:36 am

    Given that the market is a net seller of gilts because the Bank of England keeps buying more than the DMO are issuing, I’m sure that gilt holders are delighted that they’re getting top prices when they sell. I’m not too sure I’d fancy the prices were the BoE to sell its holdings. And if they carry on buying up all the gilts, we’ll end up with a worthless currency.

  4. jonathan
    Feb 11th 2012, 8:54 pm

    The survey didn’t really address the question of current policy. Yes, it listed that as a choice but a respondent could assume this policy versus a terrible one. A better survey would focus on that question in more detail: this policy versus another policy not an imaginary one that might be a disaster. One could pick current policy as a choice and have in mind any ridiculous alternative. That automatically increases the value of the current policy choice in the survey.

    I had a lot of trouble with the first comment to this post. The idea that CDS measures UK policy risk is silly. The Eurozone has issues related to the Euro so the CDS yields can’t isolate policy risk for any of them. To say they do for the UK makes no sense in that light.

    The rankings of the first two reflect different views within sensible economics: macro changes to yields caused by QE versus systemic issues. I think those who choose the former are more interested in the technical arguments.

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