Cameron Bond-Market Backing Founders as BOE Halts PurchasesDavid Goodman
The U.K. government bond market is undermining Prime Minister David Cameron’s own test of economic credibility, with yields climbing relative to global peers ever since the Bank of England halted its debt-purchase program.
Gilts have lost 2.3 percent since the central bank said it would stop buying them in November. Only Sweden gave a worse return among 26 sovereign markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. At 2.06 percent, the 10-year yield is close to a nine-month high, and up from the record-low 1.407 percent set on July 23. The average over the past decade is 3.96 percent.
Britain’s borrowing costs relative to global averages rose this month to the highest since October 2011, thwarting Cameron after he said on Jan. 6 that the “real test” of his economic policy is the interest rate investors demand to own U.K. debt. As the government cuts spending to reduce the deficit, the nation is on the brink of a triple-dip recession and the premier’s Conservative Party trails the opposition Labour Party in opinion polls.
“Putting your credibility in the hands of the market is risky, if yields go higher then you’ve lost your main trump card,” said Alan Clarke, an economist in London at Scotiabank Europe Plc, one of 21 financial institutions that trade directly with the U.K’s Debt Management Office. “The government is playing a dangerous game.”
Gilts are headed for their worst month in three years as signs Europe’s sovereign-debt crisis is easing sap demand for British securities as a refuge. They lost 2.1 percent through Jan. 30, set for the biggest drop since December 2009, according to the Bloomberg/EFFAS indexes. The pound has weakened 3.4 percent this year, the second-worst performer among 10 developed-market currencies after the yen, according to Bloomberg Correlation-Weighted Indexes.
U.K. 10-year yields will increase to 2.6 percent by the end of March 2014, according to the median forecast in a Bloomberg survey of 11 analysts. That would result in a loss of more than 1 percent for investors who hold these securities during the period, according to data compiled by Bloomberg.
With Chancellor of the Exchequer George Osborne pushing back his deficit-reduction plan by a year to 2018, credit-rating companies say the U.K. may lose its AAA grade. Osborne told parliament on Dec. 5 that his government gets “a daily verdict on the credibility of our economic policy from bond investors.”
U.K. 10-year bond yields rose as high as 2.14 percent on Jan. 4, the most since April 30. Bank of America Merrill Lynch data show the average yield on U.K. securities is 1.96 percent, 43 basis points more than the average in its Global Broad Market Sovereign Plus Index of 1,417 bonds. The difference reached 49 basis points on Jan. 4, the widest since October 2011.
Tumbling bonds mark a turnaround from the first years of Cameron’s Conservative-Liberal Democrat coalition, which was formed after elections in May 2010. Gilts had the world’s best returns in 2011 as rising borrowing costs across the 17-nation euro area increased the prospect of a breakup of the monetary union. Britain pushed ahead with spending cuts and tax increases to avoid being sucked into the debt turmoil.
With yields from Italy to Ireland now dropping as policy makers rebuild investor trust, Cameron’s government said last month the U.K.’s debt-to-gross-domestic-product ratio was expected to peak at 79.9 percent in the financial year ended March 2016, 12 months later than planned.
“Gilts, along with a lot of other high-quality assets, are losing their safe-haven status,” said Alan Higgins, the chief investment officer at Coutts & Co. in London, who helps oversee about $49 billion of assets. “The fundamentals of the U.K. look poor. What’s needed is growth.”
U.K. GDP dropped 0.3 percent in the last three months of 2012, the National Statistics Office said Jan. 25, more than analysts estimated. The economy also contracted in the first two quarters of last year.
Gilts have lost the backstop of central-bank purchases. After buying 375 billion pounds ($592 billion) of government debt under their so-called quantitative-easing plan, Bank of England policy makers led by Governor Mervyn King announced Nov. 8 they were pausing the program. The central bank held about 26 percent of outstanding gilts as of Jan. 30, according to data compiled by Bloomberg.
King’s successor, Mark Carney, who will become governor in July, said this week that central banks have room to ease monetary policy further if needed. U.K. interest rates have been kept at a record-low 0.5 percent since March 2009. In July 2007, when the 10-year gilt yield reached 5.56 percent, the highest level in the past 10 years, the central-bank interest rate was at 5.75 percent.
“BOE buying, near-zero short-term rates, and extreme risk aversion were dominant factors in low yields,” said Patrick Armstrong, a managing partner at Armstrong Investment Managers LLP in London, which oversees $350 million. “Fiscal austerity is insignificant,” he said.
The yield on 10-year gilts is 10 basis points more than similar-maturity U.S. notes. The rate was 17 basis points below Treasuries as recently as August. The spread over bunds is 41 basis points, up from 10 basis points on Aug. 6, while the cost of insuring against default on British debt has climbed to its highest relative to Germany since August 2011.
A poll by YouGov Plc based on interviews with 1,971 adults on Jan. 28 and Jan. 29 showed the Conservatives would attract 33 percent of the vote if an election was held immediately, compared with 42 percent for Labour. The poll didn’t specify a margin of error.
Labour says Cameron is damaging the economy by trying to cut the deficit too quickly, with the party’s Treasury spokesman Ed Balls saying last week that the government’s austerity measures had “choked off the recovery.”
Overseas investors increased their holdings of U.K. government bonds by 32 billion pounds last year, according to Bank of England data. That compares with an increase of 41 billion pounds in 2011. In December, foreign ownership rose by 15.4 billion pounds, the Bank of England said yesterday.
“Weaker economic growth has put the government’s debt target out of reach,” Armstrong Investment Manager’s Armstrong said. “The 10-year yield is only going to move higher, and the government will at a minimum look inconsistent if they do not acknowledge their policy may be part of the problem.”