What has happened to the UK Gilt market? Will 2013 follow late 2012 and will France overtake us?

As we approach the end of 2012 thoughts tend to turn to reviews of what has happened in 2012. Tucked in there we can in fact find some nuggets which help us in reviewing not only what has happened but what might happen. Let me open with something that some will claim as a success for the Euro area.

The Euro is strong

Headline and leader writers have lost one of their favourite lines as they cannot say that the Euro as a currency is weak or under pressure right now. At a level of  US$1.323 it has rallied strongly since the dark days of late July when it dipped below US $1.21 and it is now  higher than a year ago,if only just. Against the suddenly weak Yen -which has undergone a Samson and Delilah type transformation- it has risen from 95 Yen in late July to 111 as I type this. It is also 3% higher than a year ago at 1.23 versus the UK pound.

Happy days? Er not quite. Imagine you were an exporter in Greece,Ireland, Portugal or Spain trying to sell your products more expensively and you get the idea. They will benefit in time from an anti-inflationary effect but the last thing many of them need right now is a higher exchange rate. Please remember this should you hear any Euro area politicians crowing about this subject.

France versus the UK

It has been very nice of the government bond markets of these two countries to confirm my point that ratings agencies actions and downgrades are mostly a busted flush these days. Remember that France or should I say FrAAAnce was downgraded from AAA status but that the UK was not? Well its bond market has rallied whilst the UK’s has fallen in a clear example of markets ignoring the ratings agencies. This has become such a clear trend that the Financial Times mentioned it yesterday.

If we look back we see that in late 2011 the benchmark ten-year French bond yield rose to 1.5% over the UK Gilt equivalent. Whereas as I type this in France the rate is 2.05% and the Gilt rate is 1.98% so it has narrowed to 0.07% over. Cue cries of “Vive La Republique”and “La Gloire” and bond traders on the right side of this move have done very well.

So another possible success for the Euro area as France can now issue debt more cheaply. However, again we have a cautionary note as some of the improvement will be due to her disappointing economic present and future.

The UK Gilt Market

It would appear that one of Coldplays hits was helpful in predicting the performance of the main UK Gilt benchmark in 2012.

Oh lets go back to the start

Running in circles, coming up tails

As the yield on the ten-year Gilt closed at 1.98% in 2011 and is now 1.97%. There was a strong rally in price terms in the middle of the year but it fizzled out at yield level just below 1.5% in late August and since then there has been an upward climb in yields and lower prices.

If we look at our longer maturities we see a more disappointing situation as here yields have now risen in 2012. The thirty-year Gilt yield was 3.05% at the end of 2011 and it is 3.21% as I type this.

Regular readers will be aware that one of the themes of this blog is that low bond yields are unlikely to be permanent and that we should use falls in them to run our debt as cheaply as possible for the longer term. I am not advocating extra borrowing in itself just that one of the strengths of our national debt is that we have a relatively long maturity spectrum and if we can enhance that at relatively low yields and high price we should.

Why has this happened?

Firstly as I discussed yesterday the Bank of England is plainly in disarray. Take a look at this from the latest Monetary Policy Committee minutes which were released this morning.

the Committee’s projections published in the November Inflation Report continued to incorporate a rebalancing of demand in the UK economy towards net exports.

Is that what is happening?

The nominal trade deficit had, however, widened further in October

Oh okay but the numbers are erratic and this could be a fluke?

And more generally, the extent of external rebalancing over the past two years had disappointed.

Oh so perhaps not then! This is not good when we are talking about something they have been claiming since the pounds depreciation in 2007/08.

Still at first if you don’t suceed.

It was therefore possible that the real exchange rate consistent with current account balance might be lower than its current value

How much lower?

What about inflation?

There was a rather strong hint in the last quote above I think! Also they now agree with one of the earliest themes of this blog from 3 years ago when I began to point out that the UK has a problem with what I labelled as institutionalised inflation.

a number of domestic utility and other administered and regulated prices were set to raise inflation……….likely to contribute around one percentage point to CPI inflation over the next year, and possibly beyond that

Also they have a problem with the section I have highlighted below as it keeps happening.

The twelve-month rate of CPI inflation had risen to 2.7% in October, which had been higher than the Committee had anticipated

There is an important corollary to this which is a matter of basic competence or rather in this instance incompetence. I meet up and discuss matters from time to time with Simon Ward who used to also blog on Mindful Money and recall him mentioning his view that tuition fees would impact inflation strongly in late 2012 well ahead of events. Now see the Bank of England view on their impact.

due in large part to a greater-than-expected contribution from university tuition fees

How can a known event be “greater-than-expected”?

If we look at the forecast going forwards then even the MPC seems now unable to claim that its period over target is temporary.

Inflation was likely to remain above the 2% target for the next year or so

If I had been there I would have asked how long “or so” is?!

Also the section below is defeatist as for example it ignores the effects of the 2007/08 depreciation of the pound on the foreign exchanges.

There was little that monetary policy could do to influence these prices directly.

A very odd view you might think for a group who seem to be rather keen on the value of the pound falling again.


So even a brief dip into the latest MPC Minutes from the Bank of England gives us something of an intellectual base for the performance of the UK Gilt market in 2012. Its rally was driven by economic weakness and purchases by the Bank of England. But then they were outweighed by fears of how long the economic weakness would continue and an ever more disappointing inflation performance. Also foreign investors may be wary of a further fall in the pound’s value as this looks increasingly to be the Bank of England’s go to policy.

Although we are currently perhaps seeing another Bank of England failure as the pound has just pushed above US $1.63 which is its highest for a while.

Bank corruption

This is like the gift that keeps on giving although of course it is really taking. Today involves a large fine for Libor (Liebor) rigging for a past  employer of mine, UBS. You might wonder what the Financial Services Authority was doing back then?

On that subject here is some news on an ex-colleague of mine at UBS Hector Sants who was Chief Executive of the FSA over at least some of the period where Libor was rigged by UBS and Barclays amongst others. From the Financial Times.

Hector Sants will receive a total remuneration package worth as much as £3m as part of his move to Barclays next month, according to people familiar with the deal.

This entry was posted in Banking Reform, Banks, Barclays Scandal, Euro zone Crisis, General Economics, Gilts, Inflation, Quantitative Easing and Extraordinary Monetary Measures, Stagflation, UK Inflation Prospects and Issues, Uncategorized and tagged , , , . Bookmark the permalink.
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  • james

    Hector Sants leads an extraordinarily charmed existence IMHO. He seems to me to be the epitome of obscene rewards despite a zero contribution (or worse, as he failed to spot the banking crisis).
    Disgusting if your salary is right

  • Anonymous

    Hi James

    Speaking of salaries let me add a couple of tweets I have just published which relate to the incoming Governor of the Bank of England.

    Also the Bank of England confirms that in regards to Mark Carney £874,000 is the new £624,000! http://www.bankofengland.co.uk/Pages/home.aspx #gfc2

    Bank of England CPI inflation target is 2% . Rise in the next Governor Mark Carney’s wages just announced 40%! #gfc2 #weareallinittogether

  • JW

    Hi Shaun
    I heard a trader this morning air the view that ‘everyone was getting a little tired of the Euro issue’ implying they would increasingly be looking for a new ‘target’ in 2013. Maybe King will get his long wished for devaluation before he leaves?

  • Anonymous

    Hi JW

    It is possible but the problem remains of who we fall against. Recently both the US Dollar and the Japanese Yen have taken the baton for this with the Yen surging to the front (back) of the pack as it moves into the 84s versus the US Dollar.
    Also much of the Euro area can ill afford a higher Euro.
    It looks ever more like the Competitive Devaluations of the 1920s doesn’t it?