Lower Gilt yields should drive the UK Budget Statement

These are extraordinary times and let me bring you up to date with this morning’s developments. Bond markets have surged again with that of Germany reaching an all-time high. One way of putting that is that there are discussions this morning of the futures contract going to 180 which provides food for thought when you have traded it at 80. In more prosaic terms Germany is being paid ever more to borrow with its ten-year yield -0.73%. Why? Well let me throw in another factor from @ftdata.

Why Germany’s bond market is increasingly hard to trade: Shortage of tradable Bunds reflects huge ownership by banks and central banks

This is having all sorts of impacts as for example the bond vigilantes were supposed to be all over Italy like a rash and instead its ten-year yield has fallen below 0.9%. It reminds me of this from Shakespeare.

All the world’s a stage,
And all the men and women merely players;
They have their exits and their entrances;
And one man in his time plays many parts,

That gives us an international context to the fact that the UK Gilt market has soared this morning such that it has created something of a new reality. This is very different to past political crises because if we were in an episode of Yes Prime Minister right now it would be talking about the Gilt market collapsing rather than soaring. For once up genuinely is the new down. If we look at tomorrow’s Budget Statement then it needs to address the fact that the UK can borrow for fifty-years at an annual interest-rate of 0.8% Whatever your views on fiscal policy we should do some and views on fiscal policy should be changed by this. Let me give you a comparison as back in the day the Office for Budget Responsibility suggested the medium-term UK Gilt would yield 4.5% and rising now so the fifty-year would be say 6%. In other words we have something of a new paradigm.


Much of this comes from the policy of the Bank of England and the rest comes from the tightening of fiscal policy. As the economy has recovered we have done this in terms of fiscal policy.

In the latest full financial year (April 2018 to March 2019), the £23.6 billion (or 1.1% of gross domestic product, GDP) borrowed by the public sector was less than one-fifth (15.4%) of the amount seen in the FYE March 2010, when borrowing was £153.1 billion (or 9.9% of GDP). ( UK ONS)

Whatever your view on the concept of austerity we are now borrowing much less. So the irony is that we borrowed a lot when it was expensive and much less as it has become much cheaper.

Next let me address the Bank of England. It can do all the open mouth operations it likes and offer its Forward Guidance about higher interest-rates. But markets and potential Gilt investors note that not only did it originally buy some £375 billion of UK Gilts its knee-jerk response to perceived trouble was to buy another £60 billion. So they expect more purchases in any crisis and whilst we are not in the same position of an outright shortage of sovereign debt as Germany we are not issuing much and the Bank of England would likely buy way more than that.

Thus the two factors above are driving the UK Gilt market higher and as it happens there is another addition. This is that some pension funds find they have to buy more Gilts to match their liabilities as the market rallies and at a time of low supply that just adds to the issue. You may choose to call this a bubble but whatever you call it a number of factors are elevating the market.

Fiscal Rules

These are one of the fantasies of our times. Gordon Brown had one as did George Osborne and Phillip Hammond. Let us remind ourselves of the latter via the Resolution Foundation.

Deteriorations in the public finances and economic outlook, alongside spending commitments the Prime Minister has already made, lead us to conclude that far from any further headroom to spend, the Treasury is already on course to break the ‘fiscal mandate’ of borrowing less than 2 per cent of GDP in 2020-21. In addition, with spending
commitments building in subsequent years, it’s likely that borrowing will only further overshoot this limit in the years after 2020-21.

Kudos to them for remembering what the UK fiscal rules are. But the catch is that nobody including the politicians issuing them takes them seriously, in the UK anyway. As recently as the 21st of last month I was pointing out this on here.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

As you can see spending has risen although that was by the previous version of the current government. However the underlying trends and forces have not changed much if at all.

National Debt

This is something of a mixed bag as if you think we have a problem measuring the fiscal situation ( Hint we do..) it gets worse here. Let me give you an example of this via the Office for Budget Responsibility.

Public employment-related pension schemes and the Pension Protection Fund will be moved within the public sector boundary. This would reduce public sector net debt in 2018-19 by £30.9 billion (1.4 per cent of GDP), reflecting the gilts and liquid assets they hold. The liabilities of these schemes are not ‘debt liabilities’ – they are accrued pension rights – so do not add to the liabilities side of public sector net debt.

Yes you do have that right. A liability and maybe a large one will improve the numbers in the same way that the Royal Mail pension scheme did a few years ago. With that context here is the current situation.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

As you can see debt has been rising but in relative terms it has been falling as the economy has grown faster than it. There will be other reductions next month via the pension scheme misrepresentation above but also due to past revisions to GDP.

Above is the number which will be used tomorrow. If you wish to compare us internationally then add around 3% to it.


The context is clearly that the UK can afford to borrow. Let me specify this to avoid misunderstandings. We can choose to invest in infrastructure or elsewhere and lock in very cheap 50 year borrowing costs. Back on July 29th I suggested that we could borrow £25 billion easily and it would be more than that now,maybe much more. Personally I would also do something about the benefits freeze which has hit many of our poorer citizens.

As for other factors then do not place much faith in precision here. Regular readers will know I have challenged our national statisticians over the £2 billion fall in Bank of England QE remittances in July. Neither out statisticians nor HM Treasury can explain this and frankly I an explaining it to them! Without going into detail in my opinion at least £1.6 billion is without explanation and is singing along with Men At Work.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Is it a bad time to remind you that the way the Bank of England constructed its QE operations ( mostly the Term Funding Scheme ) has added around £180 billion to the recorded level of the national debt?

Now let me return to the issue of a pension recalculation improving the public-sector numbers. How is that going in the private-sector?

Pension deficits at 350 of the UK’s largest listed companies widened by £16bn in August, as the increasing prospect of a #NoDealBrexit drove down gilt yields, according to analysis from Mercer. ( @JosephineCumbo )


8 thoughts on “Lower Gilt yields should drive the UK Budget Statement

  1. Shaun

    Lower gilt yields will assist more borrowing and in turn help the UK economy during these turbulent times with world growth slowing and impact of BREXIT.

    Having also read your twitter blog you also mentioned lower gilt yields would in turn indicate lower mortgage rates and higher house prices!

    That is now an interesting scenario as the lower £ is suggesting a BOE rate cut!

    However isn’t all this at odds with the prediction yesterday that a no deal BREXIT would cause house prices to fall 6% ?

    I don’t go along with the worst fears on no deal BREXIT however and there being empty shelves in Supermarkets neither the public not being able to get medication and the world to stop spinning round and everyone falling off a cliff edge.

    I was also shocked at some of the comments by one MP this morning in an interview with the BBC who said a woman had been marched out of the commons at gun point and these were the “bullying” tactics of Borris Johnson.

    We are indeed in strange times without BREXIT as the word economies are slowing down and negative interest rates are becoming the norm.

    What was also interesting which I hear earlier on the BBC was the public not investing and cash is King at the moment and more and more people are investing at negative yields which suggests assets whether they be property or shares are way overvalued and the market is forecasting a collapse at some stage.

    • Hi Peter

      My twitter comment was to put it in context related to Lloyds buying the Tesco mortgage book and wondering what their game was/is?. But the underlying driver was a five-year yield which fell as low as 0.22% today in the mid-morning melee and even though it then rose to 0.28% that was a closing low. So the heat is on for fixed-rate mortgages I think especially as the banks seem to be competing.

  2. A few months back I gave a target of 0.58% for the 5yr UK Gilt yield, and had another of 0.4% but didn’t mention it because I didn’t think there was much chance of it being achieved, now 0.4% is history and it looks as if the next target of 0.127% will be hit, this just so happens to coincide with the previous low in August 2016, spooky how these ratios line up sometimes.HSBC is now doing 5 year fixed deals at 2.44% for 90%LTV, 2.05% for 85%LTV, 1.94% for 80%LTV and just 1.74% for 75% LTV – what could possibly go wrong?Free money soon folks,why bother working?There IS a free lunch!!!

    Hopefully noone on here is an investor in the Woodford Patient Capital, but it looks like it is likely to stay in intensive care and my first target target was achieved a few days ago at 38p,next is 28-29p.

    • Hi Kevin

      Yes Woodford has turned out to be an example of something that flew too close to the sun like Icarus. As to the UK Gilt market we are setting many all-time highs or yield lows. But the lowest came in the middle of the Sledgehammer QE in late summer 2016 when the 2023 and 2024 stocks briefly had negative yields. There must have been a shortage of “free” stock and I am trying to remember if there were any other factors as I type this. To some extent it is being repeated again as the 7 year yield is 0.03% lower than the 5 year.

  3. In a global forex perspective a new layer of complication enters:
    1. Check cdn vs aud 1 year chart (2 similar resource/real estate based economies with low gov GDP debts). Ouch!
    Forex movements disguise gain/pain!! Then add USD/CME
    Commoditity based pricing! It’s tricky!

    • Hi Canuckistinian

      Back in the day when I was a new/young trader one of the few currencies that the UK Pound £ would usually rise against were the Loonie and the Aussie. The commodity boom blew that out of the water….

  4. Shaun, are you actually coming round to the idea that governments should be running larger deficits, adding more financial assets to the private sector to meet the very obvious demand?

    • Robert,

      I was thinking the same thing but Shaun may have been making a simple point that reduced borrowing costs does allow more to be spent on infrastructure and such like, however it is up to Shaun to clarify his position on that one.

      I don’t like an increase in public debt but if the raising of public debt can prevent the UK in a crisis situation it must be considered.

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