Wednesday, 16 May 2012

Gilt yields and confidence (again): the Prime Minister vs. the Bank of England

I've written on this before in depth, most recently here, but I thought the juxtaposition of what the Prime Minister said today, and the Bank of England's analysis in its Quarterly Inflation Report, also today, was worth noting.

The Prime Minister argued:  
The fact is that today British interest rates are below 2% because the world has confidence that in spite of our economic difficulties we have a plan to deal with our debt and our deficit
The Bank has a rather different perspective (page 12):  
Gilt yields remain close to historically low levels. Domestic and international factors are both likely to have depressed yields. Domestically, the MPC’s asset purchase programme and expectations that official interest rates will remain low have reduced gilt yields. The current level of yields could also reflect expectations of weak output growth in the longer term: the implied cost of government borrowing for five years in five years’ time is also close to historically low levels, largely reflecting low real rates. Internationally, persistent concerns about euro-area periphery countries have contributed to strong demand for sovereign bonds — including those of the United Kingdom — that are perceived as more liquid or carrying little credit risk. That is also likely to have contributed to the current depressed level of gilt yields."
Obviously, all the domestic factors identified by the Bank - the asset purchase programme (quantitative easing), expectations of low official interest rates, and expectations of weak output growth - reflect economic weakness, not confidence. If the economy was doing fine, we'd have significantly higher short rates,  the Bank would be reversing QE, and expectations for the future would be for strong growth. Gilt yields would be higher, and this would be good news.  

Internationally, the lack of credit risk on gilts definitely does help, as the Bank says, but of course we never lost it; what is going on is that credit risk is increasing for some eurozone countries.  The difference is of course that we have our own currency, central bank and a floating exchange rate, as I explain here

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