Breakingviews - UK gilts’ odd stability is precarious

A man walks past the Bank of England in the City of London, Britain, February 7, 2019.

LONDON (Reuters Breakingviews) - Fiscal responsibility is old hat in Britain. Both Prime Minister Boris Johnson and his opposite number, Labour party leader Jeremy Corbyn, are engaged in a bidding war to woo voters before a December election. Surprisingly, this has yet to take much of a toll on UK government bonds.

The yield on Britain’s benchmark 10-year government bond is 0.77%, within the range that has prevailed since Oct. 11 and little changed since lawmakers approved Johnson’s plan to hold an election on Dec. 12. Moreover the gap between UK and German bond yields is fairly steady. Such resilience appears a bit odd given the spending promises.

Combine Corbyn’s 10-year 250 billion pound infrastructure plan with Labour’s 2017 election promises and public spending would rise above 43% of GDP, surpassing the 1970s average, according to the Resolution Foundation. Johnson’s plans to spend more on infrastructure and services would push expenditure above 41% of GDP by 2023 from about 40%, the think tank said. Add the cost of extra health outlays for an ageing population, and spending would again top the 1970s average, it said.

True, some spending may be financed by tax rises. But gilt yields have been insensitive to electioneering for other reasons. First, there’s speculation the Bank of England might ease monetary policy again, especially if Britain were to exit the European Union in a disorderly way next year. Second, European Central Bank President Christine Lagarde’s asset buying will keep a swathe of euro zone bond yields below zero and increase the allure of UK gilts which still carry positive yields. Third, there’s demand from UK pension funds and life insurers who need assets to match long-term liabilities.

But it wouldn’t take much to destabilise gilts. An orderly Brexit that makes a rate hike more likely than a rate cut might do the trick. Or a big increase in the amount of gilts issued to finance spending. Less likely, but also possible, is the risk that investors take fright if Labour is elected, triggering a collapse in sterling and shift out of UK assets. The party’s plans to nationalise utilities and raise taxes on companies may unnerve money managers, while a falling pound makes gilts less attractive to foreigners. Since either a Johnson or Corbyn victory could lead to some or even all of those outcomes, UK bonds may not have long to enjoy their precarious perch.


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