The UK Treasury could breathe a sigh of relief that today it managed to sell 2039 UK government debt relatively easily. They will recognise, however, that when you need to borrow £175 billion a year and refinance retiring debt you have to repeat that success week after week. The sum borrowed was less than a week's requirement. Meanwhile, the pound has taken more of the strain in the last few days, falling below $1.50 and giving up some ground against the Euro and other leading currencies.
The problem with wishing to borrow so much is it leaves a government vulnerable to market whims and moods. In the last few days the currency market has taken fright from Opinion Polls, suggesting there could be a hung Parliament after May instead of a clear win for a new government. Markets hate uncertainties - though they also move and make money from them. Market participants want to be reassured that the next government, whatever its composition, is going to take reducing the deficit seriously. A hung Parliament might delay painful choices, so markets might decide to force their hand instead.
If we look at the range of yields on European government bonds, we see that many countries now have to pay more than the 3.14% Germany is offering for a 10 year loan. Spain pays 3.84% today, Portugal 4.34% and Greece 6.12%. Outside the Euro zone, with no suggestion of German government support, the UK currently is paying 4.06% for 10 year money.
Evercore Pan Asset has been warning for many months that UK gilts might not be a good investment. We have watched as yields have risen and prices fallen. At the same time the pound has also tended to fall. During the long period of quantitative easing the government and Bank of England bought up £198 billion of gilts, an amount in excess of the sums they needed to borrow at the time. Despite that extraordinary intervention, gilt prices tended to fall. We sold all fixed income gilts in portfolios brought to us where we had a full discretionary management mandate, preferring overseas and UK corporate bonds with higher yields. The overseas bonds also offer currency gain when the pound falls.
Investors still holding UK government bonds must believe that government will soon rein in the spending and control the deficit, to limit the supply of such bonds. Additionally or alternatively they may believe that the current upturn in inflation is temporary, that there is substantial deflation around the corner, and that interest rates are going to stay low for a long time. These are possible scenarios, but not very likely ones.
It seems more likely that the trend of interest rates is up from here. India and China have to tighten to curb inflation. UK and US short rates are at historically low levels and will have to go up some day. UK inflation may decline later this year, but the more the pound falls the more inflation we will import. The task of curbing the deficit requires spending cuts on a scale not seen before. The election delays action to grapple with this problem.
We are sticking with our view that in these conditions UK government debt is a risky investment. Lending money to the UK government at a little over 4% does not look like a very enticing proposition. If you missed today's gilt auction and are worried about that, there will be another along any day soon. Meanwhile, those who went with the advice to be invested overseas in stronger economies and currencies are now making good money out of the latest devaluation of the pound. Every fall in the pound makes the UK less well off and imports some more inflation, as offsets to the improvement in export prices or profits.