Borrowing costs

UK government borrowing costs hit record highs

British government borrowing costs hit record highs on Friday, underscoring investors’ willingness to fund further economic stimulus measures outlined this week by Chancellor Rishi Sunak.

The latest rise in bond prices pushed yields on short-term debt even further below zero. Five-year UK government bond yields fell to minus 0.09%, while two-year yields fell to minus 0.13%.

Negative yields now cover all gilts with maturities of up to seven years, meaning investors are willing to pay the government to take their money – largely because of the huge demand resulting from the scheme purchase of Bank of England bonds. This has allowed the government to take on new debt to support the economy during the Covid-19 crisis, with measures ranging from paying furlough schemes to subsidizing restaurant meals.

“We had absolutely massive supply of gilts, but even greater demand,” said Mike Riddell, fund manager at Allianz Global Investors. “The BoE ate all the extra gilts.”

The catalyst for Friday’s moves was a broader rally in prices for the safest government debt after a spike in coronavirus cases in the United States prompted investors to seek safe-haven assets. A recent spike in virus deaths in Florida has fueled fears the outbreak could stall a fragile recovery in the world’s biggest economy. Germany’s 10-year yield fell to a four-week low of minus 0.52%, while the equivalent US Treasury plunged to its lowest level since April at 0.58%.

Prior to the recent crisis, any significant increase in government borrowing would normally have driven bond yields higher. But yields have remained low since the onset of the crisis and are unlikely to rise, given subdued inflation risks and long-term central bank support.

Mr Sunak presented a series of measures on Wednesday that are expected to boost government borrowing to £350bn this financial year. The budget deficit is on track to increase to almost double the level reached at the height of the 2008-2009 financial crisis.

The BoE’s bond-buying programme, which was expanded by £100bn last month to £300bn, has helped keep bond prices high. So far, central bank purchases have grown at a faster rate than government bond issuance.

Gilts may struggle to rally further, Riddell said, as the BoE’s buying rate is expected to fall below new issuance over the coming months. However, further bad news about the spread of Covid-19 could boost investor demand, he added.

The negative yields also suggest that the BoE could cut interest rates further, potentially following Japan and the Eurozone in setting negative short-term interest rates.

BoE Governor Andrew Bailey said in May that the policy was under “active review”, after downplaying the prospect. Since then Mr Bailey has reportedly written to banks warning them of the challenges of negative rates.

Money markets are forecasting a zeroing of 0.1% by the middle of next year, and a lesser chance of a drawdown into negative territory thereafter.

Letter in response to this article:

Sunak should stick to selling gilts in the long run / By Jan Toporowski, Professor of Economics and Finance, Soas University of London, London WC1, UK