Debt monetisation by the Bank of England

Today sees the release of the latest public finances data for the UK and they have been genuinely changed by the Brexit Referendum. Some care is needed here as there is a clear and present danger of Brexit fatigue setting in as highlighted by RANSquawk yesterday.

minutes mention “referendum” 33 times!

However the genuine change I am referring to is the way that the leave vote has accelerated an existing trend towards lower borrowing rates for the UK government. We have seen UK Gilt prices surge and thus yields plunge with a couple of brief episodes of negative yields in the 3/4 year maturity region.

Bank of England

The Bank of England is currently doing its best to drive Gilt yields even lower and has undertaken 3 further rounds of  purchases of UK Gilts totalling some £3.51 billion this week alone. There will be no further purchases today because the bond buyers at the Bank of England find those 3 days to be so stressful and tiring that they then need a 4 day weekend to recover!

However the crucial point was made on Tuesday when Gilts maturing in the 2060s were purchased. You see the Bank of England bought at yields of 1.13% (2060), 1.14% (2065) and 1.15% (2068). A pittance or a mere bagatelle. It is hard not to have a wry smile at the shape of the UK yield curve these days but let me move on as that is something for those who have followed it for many years as I have. The fundamental point as I have been making in my articles on fiscal policy is that such yields completely change the position as we can now borrow for fifty years amazingly cheaply. Unless there has been a complete revolution in the UK inflation outlook then these represent negative real or inflation adjusted yields and quit possibly substantially negative ones. It was only on Wednesday that the RPI inflation index was recorded at 1.9% which means compared to it all of our Gilt yields are lower now and even the CPI is on its way up in spite of the effort to keep it low via the omission of owner-occupied housing.

Also there is the issue of the prices the Bank of England is paying which was 198,150 and 191 respectively for the 3 Gilts maturing in the 2060s. If it is to hold these to maturity then it will only get 100 back in nominal terms which is likely to be heavily depreciated in real terms. If it sells them along the way then it will require someone to pay more than what are record highs driven by it. On that road you get the QE to infinity argument or as Coldplay put it in the song trouble.

Oh, no, I see
A spider web, and it’s me in the middle,
So I twist and turn,
Here am I in my little bubble,

What can we actually borrow at?

Some care is needed as the Gilt market is plainly gaming the Bank of England as they know it has to buy to back up the words of its Governor Calamity Carney. Also the promises of its Chief Economist Andy Haldane as what use is an empty sledgehammer?

Yesterday we sold an extra £1.25 billion of our 2055 Gilt at a yield of 1.21% so if we look at infrastructure projects there must be at least some room for manoeuvre as I suggested on the 4th of this month.

So there is scope on that basis but my suggestion is that we start from the more micro level than the grand macro plans which have so let us down in the credit crunch era. Rather than money looking for projects let us go the other way and look for projects that we feel would genuinely be beneficial. I am open to suggestions but as I discussed only on Friday the UK’s power infrastructure seems to have plenty of scope for ch-ch-changes and improvement to me.

There were quite a few suggestions in the comments for those wanting to think more about this.

Debt monetisation

I raise the concept because whilst we are not seeing this in its purest form there are issues when the Bank of England buys Gilts in a maturity zone on a Tuesday and we sell one on a Thursday. Just to be clear it did not buy the 2055 Gilt and will not do so next Tuesday.

UKT 4.25% 2055 is excluded from the 23/08/16 operation because it has been auctioned by the DMO within one week of the purchase operation.

However when I worked in the Gilt market a lot of business was one Gilt versus another. Back then younger readers may be amused to learn that whilst there was some computer support I amongst others would do such calculations in our heads. How archaic and perhaps even antediluvian! These days though surely an algorithm style operation could do it in a millionth of a second. Now where does that leave the concept of debt monetisation? Not explicit but presumably implicit.

Today’s data

Nice to see a surplus and it was caused by July being a month for self-assessment income tax payments albeit a minor disappointment in the size.

Public sector net borrowing (excluding public sector banks) was in surplus by £1.0 billion in July 2016; a decrease in surplus of £0.2 billion compared with July 2015.

Here is a little more perspective.

Public sector net borrowing (excluding public sector banks) decreased by £3.0 billion to £23.7 billion in the current financial year-to-date (April to July 2016), compared with the same period in 2015.

The revenue situation seems to be responding to the economic growth seen.

This was around 3% higher than in the previous financial year-to-date, largely due to receiving more Income Tax, Corporation Tax and National Insurance contributions, along with taxes on production such as VAT and Stamp Duty, compared with the previous year.

In July itself it was particularly nice to see this as it has been a bone of contention for a while.

Corporation Tax1 increased by £0.6 billion, or 8.4%, to £7.5 billion

National Debt

It was hard not to have a wry smile at this part of the report.

This is the second successive month of debt falling on the year as a percentage of GDP and indicates that GDP is currently increasing (year-on-year) faster than net debt excluding public sector banks.

Chancellor George Osborne made a big deal out of that issue but despite various wheezes and not a little financial misrepresentation it remained elusive and outside his grasp. Now it arrives just after he gets the order of the boot. Life’s not fair as Lilly Allen reminds us.

Care is needed as it is only for two months so far. Also on the subject of misrepresentation we publish debt to GDP numbers that are on a different basis to other countries. This is not well explained by the media as many are unaware of it themselves, I still remember BBC Economics Editor Stephanie Flanders demonstrating poor knowledge of the subject matter. So having pointed out that Spain passed 100% yesterday here are comparable numbers for us.

general government deficit (Maastricht borrowing) in the financial year ending March 2016 (April 2015 to March 2016) was £74.5 billion, equivalent to 4.0% of GDP

general government gross debt (Maastricht debt) at the end of March 2016 was £1,649.2 billion, equivalent to 87.7% of GDP.

Comment

We find that the fiscal envelope of the UK has changed considerably in a short space of time. There is an irony that our patchy progress on the issue of our fiscal deficit, especially if you factor in the economic growth since 2013, has moved away from the front of the queue. The replacement has been the fact that we can now borrow so cheaply for the long-term and this provide plenty of opportunities as we note that the “bond vigilantes” are at least temporarily impotent.

However I counsel caution as if low bond yields and fiscal deficit spending were certain cures for the credit crunch malaise as many are now claiming then Japan would not be in the economic mess it is in would it? But we seem to be fulfilling at least a bit of what the Vapors promised.

I’m turning Japanese I think I’m turning Japanese I really think so
Turning Japanese I think I’m turning Japanese I really think so
I’m turning Japanese I think I’m turning Japanese I really think so
Turning Japanese I think I’m turning Japanese I really think so

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20 thoughts on “Debt monetisation by the Bank of England

  1. Infrastructure borrowing costs are very low and it should encourage Chancellor Hammond to take on some spend but where.
    1. Housing associations; councils for low cost housing. Obvious need.to bring down price of rent.
    2. UK oil reserve is still awaited and should be got on with.
    3. The Isle of Wight tunnel or bridge.
    4. Government funding to assist farmers combine land into genuine national parks with wild wolves, bears, lynx and prey based creatures running about really wild and getting eaten or eating with tourists taking pictures.
    5. Salmon river repopulation.
    6. Oil refineries so we stop importing jet a1 and diesel.
    7. Natural gas power plants for when the wind doesn’t blow and it is cloudy.
    8. Heathrow and or Gatwick new runways. What is keeping this back.
    The list is endless but I agree more micro based is a good way forward.
    He should be looking at how his budget will help fix the current account. Yes, import substitution, but I also mean added value on commodities.

    • 4. Government funding to assist farmers combine land into genuine national parks with wild wolves, bears, lynx and prey based creatures running about really wild and getting eaten or eating the tourists taking pictures.

      there, better

      forbin

  2. Endless as you say:
    9. Fibre optic to every door in the country and buidling regulations requiring it for every new build. (Wonder if Battersea Power station flats have that?)

  3. we can now borrow so cheaply for the long-term and this provide plenty of opportunities

    for masterly inaction !

    after all we need all the money we can get to save the Banks again next year ….

    Forbin

    PS: and the year after that

    • Hi Forbin

      Yes there was a familiar name in the news earlier this week as the Co-op bank declared yet more losses. They tried to blame Brexit but even the FT put it like this “Co-op Bank: Crystal Methodist’s toxic legacy”.

      So yes every year we see more trouble at RBS and the Co-op. Indeed the list of troubled banks seems to go on and on in time. From SoberLook.

      “Italian Banks Continue to Lend to Stagnant Companies as Debt Pile Mounts http://nyti.ms/2b0EOYX UniCredit down 6% – “

    • Hi Chris

      Let me give you some more detail on the UK revenue numbers.

      “Central government receipts in July 2016 were £61.8 billion, an increase of £2.0 billion, or 3.4%, compared with July 2015. Of this:

      Interest & dividend payments increased by £0.8 billion, or 79.9%, to £1.8 billion
      Social (National Insurance) contributions increased by £0.6 billion, or 6.9%, to £9.7 billion
      Corporation Tax increased by £0.6 billion, or 8.4%, to £7.5 billion
      Income Tax-related payments increased by £0.4 billion, or 1.9%, to £18.9 billion
      VAT receipts increased by £0.1 billion, or 1.3%, to £11.0 billion
      Tobacco Tax decreased by £0.5 billion, or 38.2%, to £0.8 billion”

      Are people smoking less? Let us hope so ……

  4. Great piece Shaun thank you.
    Gordon Gekko would now say “debt is good” it is the only game in town.
    Yet excessive debt always has a day of reckoning our government and central bank are playing the same game as those people who have bought houses at prices they could not afford.
    Can you hear that ticking sound it is the debt/derivates bomb and when it goes off we will experience the worst economic event in history.

    • Hi PrivateFraser and thanks

      The debt/derivatives front continues to trouble me. For example what about the impact of the oil price fall of just under 2 years ago? The world seems increasingly unable to deal with price swings of any great magnitude.

      As to the debt if we cannot find projects that will make borrowing at less than 1.5% for 50 years worthwhile then a grin future awaits us.

    • Hi thepessimist

      Thanks for pointing out that negative interest-rates has arrived in the UK and that surprise,surprise RBS is in the van! As to Alice through the Looking Glass I would put it under both fact and prescience.

  5. Hi Shaun,

    Another good blog.

    How about investing in a central bank agony aunt as I feel she will be in great demand over the next few years, where the Western central banks consider “Pump up the Volume” for Sovereign debt and asset inflation are the only game worth playing in town. Japan, Greece and Portugal will all fight for first place in what is going to become a very long queue.

    Scrap the vanity HS2 project and to spread the London effect and commuter radius then we need a proper 21st century very high speed (using maglev rather than Victorian steel rail technology) railway system, that will compete with air travel. London to Manchester in 30 minutes or Edinburgh in an hour. With this house prices will become more equitable and the north-south divide will become much smaller.

    With Crossrail nearing completion, press on with Crossrail 2 and get the extra runways built at Heathrow and Gatwick, where delays are common due to almost 100% runway capacity loading.

    • Hi Rods and thank you

      I do tend to agree that we need to improve railway technology. By that I mean both ways firstly by a more high tech approach to main lines as you suggest but also more light railways such as the one from Croydon and Crystal Palace.

      As to new runways I would prefer the new one to be at Gatwick but confess a bit of Nimbyism there as when the winds are in the wrong direction for me then my part of Battersea finds itself on the Heathrow flight path.

  6. Shaun,
    Many thanks for breakdown of numbers – apologies for new comment as unable to reply to your response.
    I note the increase in NI is greater than that for Income tax!
    Meanwhile Corp Tax take less than both of the above and VAT.
    Hopefully less tobacco consumption so sugar tax to improve everyone`s health?

    • “I note the increase in NI is greater than that for Income tax!”
      A clear indication that the jobs being created are lower paid as NI conts become payable once the lower earning threshold of £112.00 per week currently is breached, whilst income tax only becomes payable once the weekly tax free allowance of £211.53 is breached.

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