Britain’s safe haven status won’t last

 
Allister Heath
SOMETHING seemingly astonishing is happening. Despite suffering from a gigantic budget deficit of at least £120bn, out-of-control inflation and an economy that has ground to a halt, investors are giving Britain the thumbs-up. The cost at which the government can borrow keeps on falling, and reached its lowest level since the 1950s yesterday. In real terms, investors are now paying a massive fee to the government for the privilege to lend it money; yesterday, the yield on 10-year gilts was 2.23 per cent (against 1.77 per cent for Germany, 3.47 per cent for France, 5.86 per cent for Spain, 6.89 per cent for Italy and 25.4 per cent for Greece).

Sadly, this is not primarily a vote of confidence in the UK. Sure, the UK is rightly sticking with its austerity plan; that is non-negotiable, a prerequisite for survival. It beggars belief that Labour and various groups are still calling for a reversal of this plan and an even greater increase in debt in the midst of global debt crisis.

But the main reason why Britain is in a far less disastrous position than others is that the Bank of England has been turned into the government’s lender of last resort. It is purchasing another £75bn in gilts as part of quantitative easing; the European Central Bank, in theory, is not going to backstop Italy and Spain (in practice, it is buying Italian bonds, which is why its cost of borrowing fell back a little yesterday). Britain is benefiting from having retained its own currency and central bank, though its present policy is taking huge risks with inflation.

Yet our present rock-bottom gilt yields are utterly unsustainable. They are in mega-bubble territory, as are US Treasuries and German bunds. As the bubble bursts in other economies, and investors pull out, nations deemed as temporary safe havens are benefiting from lower yields. The cost of borrowing will eventually have to rise – and that will not be a bad thing, as artificially low gilt yields are crippling pension funds and destroying the value of many savers’ pension pots. But at least the government has been given some breathing space.

It will need it in the coming months. Yesterday was a relatively uneventful day, partly as it seemed that Greece and Italy would soon both be run by coalitions of technocrats (short-sighted investors like these sorts of arrangements, failing to realise that governments that don’t take their electors with them via the democratic process never succeed). But this won’t last: France and Spain will be next to face the pressure on borrowing costs. The possibility that the euro and EU could unravel completely will trigger a last-ditch, desperate attempt at radical change. France and Germany will try and forge ahead with some sort of quasi-merger, going headlong for political, fiscal and economic union, perhaps with a few other nations. From their perspective, better to ditch weaker countries than to lose 60 years of European political integration. It will be a massive gamble – electorates may revolt. But it has more of a chance of succeeding than any broader plan to unify the whole of the Eurozone.

Crucially, it will give Britain a unique chance to extricate itself from those parts of the EU it doesn’t like. The problem for David Cameron is that what ought to be a golden opportunity could end in chaos, with the coalition tearing itself apart. He should enjoy the UK’s safe haven status – it cannot and won’t last.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath