Gilts as a safe haven for investors
Whatever floats your boat
Long-term interest rates are mercifully low, despite Britain’s huge budget deficit
A FORMER chairman of the Federal Reserve, Paul Volcker, once compared financial markets to a sea that was prone to occasional storms. It was better, he said, to be on a big ship when the waters got choppy. But recent events have turned this logic on its head. Market squalls have tossed some of the bigger vessels in the euro-zone flotilla, including Italy and Spain. Nervous investors are jumping instead into some of Europe’s outlying bond markets, such as Sweden, Denmark—and Britain. Although an unlikely haven because of its weak economy, huge private debts, high inflation and swollen deficit, Britain’s ten-year bond yield—ie, the price the Treasury must pay to borrow money for a decade—fell to a record low of 2.2% this month.
Plunging bond yields are not grounds for great cheer. In part, they reflect a fearful retreat from riskier equities and an expectation that low interest rates as a medicine for a sick global economy will be around for a while. But the chancellor of the exchequer, George Osborne, has been quick to claim that the drop in the government’s borrowing costs indicates the markets’ confidence in his deficit-reduction plan.
There is something to this. In early 2010, even as the euro’s debt crisis was building, Britain’s bond yields were on a par with those of Spain, which has a similarly large budget deficit but smaller public debt. Their paths have since diverged (see chart below). Bond markets, it seems, have taken a more clement view of Britain than of Spain, even though GDP has risen by only 0.7% in the past year in both countries. Mr Osborne’s plan, first unveiled in June 2010, has helped distance Britain from fiscal troubles in the euro zone. It may, of course, simply be that the fetters of euro membership alarm investors more than red ink.