IF you’re in a crowd that’s at risk of being shot at then it helps to be behind someone else and preferably behind something that poses a much bigger target. And that’s where the UK finds itself, shielded from the fire of ratings agencies and bond vigilantes by the Eurozone and the US.
In part the “austere” image George Osborne launched as then-shadow Chancellor at his party conference nearly two years ago has paid off. Compared to its peers, international investors see a British government with a firm plan for fiscal tightening and an independent currency.
As a result our government debt is in the unusual position of being a safe haven play. In the last week two- year gilt yields hit a record low of 0.51 per cent and 10-year yields hit 2.59 per cent.
But that’s only part of the story. For while George Osborne will claim low yields are a vote of confidence in policy they are also low because growth prospects are weak. As Baring Asset Management’s Alan Wilde says: “With RPI inflation running consistently above five per cent, real returns to gilt investors and, more critically, on bank deposits, are deeply negative.”
Sadly that includes some pension funds which, because of regulatory demands to match long term assets and liabilities, will be buying 30-year bonds yielding under four per cent.
But it’s not just UK pension funds. As Wilde points out: “Foreign holders of gilts now own more than 30 per cent of total debt outstanding, up from 18 per cent 10 years ago. Depending on the continued support of foreign investors at current nominal yields is wishful at best as they are simply not receiving a positive return, after taking inflation into account.”
So with lower growth and a larger foreign holding of our debt the pressure is only going to rise on the chancellor. He’s going to have to deliver even more on what he started in Manchester two years ago.
As Danny Gabay and the team at Fathom Consulting have demonstrated, the cost of lessening fiscal plans would “at best trigger a monetary tightening – at worst a sovereign debt crisis”.
What the chancellor needs to do is rein in his coalition partners and go much further with supply side liberalisation, to make the UK a standout economy for overseas investors. This means a radical overhaul of the tax code, reducing taxes that hinder job creation, cutting the 50p higher rate and vast swathes of business red tape.
He also needs to make sure we don’t implement fresh regulation of our banks that sucks even more money out of the economy at a time we can least afford it.
Ross Westgate is co-anchor of CNBC’s Worldwide Exchange