Borrowing costs

Britain’s borrowing costs turn negative – with huge implications for government policy | Economic news

This has been commonplace for some time now, in countries like Germany and Switzerland, but today the UK has been able to join the enviable ranks of those countries that are effectively in a position to charge investors. the right to lend them.

A UK government IOU auction – gilts – saw the Debt Management Office, the Treasury agency that manages the government’s treasury and debt management, sell for £ 3.8bn of ‘three-year bonds with a yield of -0.003%.

This means that whoever buys the obligations involved and keeping them until they expire will result in a loss of money.

It also means that whoever purchases these gilts is effectively paying the UK government for the right to lend them.

Demand has been strong for the issue, with investors asking to buy more than twice as many debt securities as those auctioned.

The DMO has previously sold very short-term paper – like one and three-month notes – with a negative yield, but this is the first time that a longer-dated gilt has been sold with a negative yield.

This development has enormous implications for how government policy might be conducted in the years to come.

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The auction opens up the alluring prospect for ministers of being able to borrow large sums of money relatively inexpensively.

The government faces a major expansion in borrowing this year due to the extraordinary measures put in place to protect jobs and businesses in the wake of the COVID-19 lockdown.

A Treasury document leaked to the Daily Telegraph two weeks ago suggested the government may seek to fund this borrowing through a combination of tax increases and cuts in public spending.

The government was quick to downplay the report’s importance, pointing out that Treasury officials had simply presented options to ministers, while indicating that the loan was more likely to fill the void.

And this argument will have been reinforced by today’s events.

After a decade of disciplined government spending, there is little public or political appetite for more austerity, something the Chancellor had indicated even before the COVID-19 pandemic.

Tax increases are also seen as a failure since they are seen as stifling growth.

Indeed, rather than raising taxes, many Tory MPs would rather see tax cuts as a way to boost growth as the UK emerges from lockdown.

Thus, the very first auction of a gilt with a negative return raises the tempting prospect for ministers of being able to borrow large sums of money relatively inexpensively.

This is an option that was not available to the coalition government, after the financial crisis, which was forced to impose both tax increases and spending cuts in the face of threats of deterioration in solvency. of the United Kingdom by rating agencies.

There will also be implications for the Bank of England.

It cut the policy rate, its main policy rate, to an all-time high 0.1% in response to the crisis, but has so far weathered negative interest rates in the same way some of its peers – like the European Central Bank, the Bank of Japan and the Swiss National Bank – have.

However, the Bank Governor Andrew Bailey said today that it would be “foolish” to rule out such a decision.

It comes after Andy Haldane, the BoE’s chief economist, recently suggested that lowering interest rates below zero remains a possibility.

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As a result, the fact that a three-year gilt was sold to investors at a negative yield seems certain to rekindle speculation that negative interest rates are on the way, especially as two-year gilts have tend to move closely with market expectations for the discount rate. .

As Richard Carter, head of fixed interest rate research at wealth manager Quilter Cheviot, said: “Today’s sale of a three-year government bond at rates of Negative interest was a historic moment and demonstrated the continued demand for UK gilts despite increasing emissions.

“It will also fuel the debate over the Bank of England’s interest rate policy and whether it will follow the ECB’s lead in taking the official negative rates.

“Recent comments from MPC members suggest they are keeping their options open and could ‘turn negative’ if the economy stagnates in the second half of 2020.”

Aaron Rock, chief investment officer of fund manager Aberdeen Standard Investments, added: “The decline in negative gilt yields has been facilitated by the Bank of England’s current quantitative easing buyback program and the ongoing debate in within the Monetary Policy Committee on the potential for key rates in the United Kingdom.

“Whether the MPC chooses to adopt negative policy rates or not, due to low inflation there will be continued demand for gilts at low and negative yields.

“The MPC is likely to increase the size of its quantitative easing program in June, and reserve managers and other investors continue to view the UK as retaining institutional credibility and low credit risk.”

Meanwhile, while the sale of a gilt with negative yield will undoubtedly make the headlines, two more gilt auctions in the past two weeks will have elicited most sighs of relief from the Treasury.

The sheer amount of government borrowing in response to the COVID-19 crisis means that large gilt issues are also being considered.

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Some £ 180bn of debt is expected to be sold between May and July of this year.

Thus, the DMO will have been reassured by the fact that demand was exceptionally strong for a new 10-year gilt auctioned on Tuesday last week.

The DMO sold £ 12bn in debt but received orders worth £ 82.6bn – a record for a gilt of this maturity.

This was followed on Tuesday of this week by an auction of a new 40-year-old gilt.

The DMO raised £ 7bn through the sale but attracted orders worth £ 53.1bn.

Both sales show there is no shortage of investors willing to lend to the UK government for long periods at relatively negligible interest rates.

This says a lot about how investors view UK creditworthiness, but will also be a relief for ministers as they consider the vast amounts of government borrowing to come.

Others will have a different point of view.

Gilts yields are the basis on which pension fund deficits are calculated – the lower the Gilts yield, the higher the deficit.

According to the Pension Protection Fund, the pension lifeboat, every 0.1 percentage point drop in long-term gilt yields increases pension fund liabilities in the UK by around £ 34 billion.

Thus, negative returns on gilts will have the impact of widening pension deficits – a prospect to ensure sleepless nights for CFOs of UK companies with large pension plans.