UK Edition
Rush to sell off UK bonds amid inflation fears
British government bond prices have fallen back to their pre-referendum level, as worries over inflation and the post-Brexit economy mean investors are demanding a higher rate of interest in exchange for lending to the UK.
Bond yields – the rate of interest, which moves in the opposite direction to the price of bonds – dived in the immediate aftermath of the referendum and fell further in August when the Bank of England chopped interest rates.
The Bank of England also re-commenced its bond-buying programme, promising to snap up another £60bn of government bonds, a move which was designed to push the price of bonds up and the yield down.
That programme of quantitative easing (QE) pushed the government’s 10-year borrowing costs down to just 0.5pc in August.
The rate has climbed since then, rising sharply this month to hit 1.1pc, the highest rate since June.
The rise indicates some reluctance in global bond markets to invest in the UK, but economists said there is little need to worry.
“There are good reasons to avoid alarmism: yields remain below their level on 23 June, in contrast to other major economies; the cost of borrowing is still remarkably low by historical standards,” said Martin Beck at Oxford Economics.
“The increase in yields since August is entirely accounted for by a rise in inflation expectations, not real rates; and rising yields have been accompanied by rising equity prices.”
Mr Beck said that the 10-year yield has averaged 6.4pc over the past 80 years.
Even six months ago the bonds were trading at a yield of more than 1.3pc while a year ago the gilts traded at more than 1.8pc.
Other economists also said that investors are showing less worry over the risk of investing in British government debt.
“After a surge in the aftermath of the Brexit vote, the cost of insuring against a default by the UK government (reflected in credit default swap premia) is now back to where it was before the referendum,” said Julian Jessop at Capital Economics.
That does not mean the rising yields are over, however – investment bankers at Morgan Stanley, for example, are recommending that investors short the bond, meaning they will benefit from a further fall in prices and rise in yields.
Inflation is expected to keep picking up as the fall in the pound feeds through into retail prices, pushing investors to demand a higher return on bond investments as protection against the value of the pound being eaten away.
“Rising energy and import prices look set to push up retail price index (RPI) inflation to about 4pc in one year’s time, exceeding markets’ current 3pc expectation,” said Samuel Tombs at Pantheon Economics.
“We therefore still think gilts are mispriced for the looming inflation shock.”
It also does not mean that there is no impact from the rise in gilts.
The government benefits from low interest rates which keep its funding costs low and make it cheaper to service the enormous national debt, which is continuing to grow as the Chancellor, Philip Hammond, has decided to scrap George Osborne’s plan to balance the books by 2020.
As the yield rises, borrowing costs creep back up once more.
A fall in the price of bonds also damages the Bank of England’s bottom line. It is increasing its holding of government bonds to £435bn, and a large fall in the value of those bonds would represent a cost to the Bank – though it is covered by an indemnity from the Treasury to protect it from any losses.
When the Bank started buying bonds in 2009, the yield on 10 year gilts stood at more than 3pc, showing that, so far, its portfolio of bonds has gained in value rather than fallen.
Officials are also buying £10bn of corporate bonds in an effort to boost the flow of cheap funds to companies wishing to invest, which could also be encouraging more bond issuance – countering the Bank of England’s drive to push down bond yields.
The fresh rise in gilt yields came as sterling enjoyed a relatively stable day on the currency markets.
The pound held steady against the US dollar at $1.218 and against the euro at €1.108.