THE UK government’s 10-year borrowing costs dropped to a record low yesterday.
The interest rate on a 10-year UK government bond – a state IOU – reached a trough of 1.396 per cent before rising marginally towards the end of the day.
“You can safely say this is the lowest ever rate on a 10-year gilt [UK government bond],” a spokesman for the Debt Management Office told City A.M.
He also pointed out that the interest on 50-year gilts are at record low of 2.08 per cent.
Part of the reason is a lower outlook for inflation. If inflation is expected to be higher, investors demand a higher rate of interest to keep the “real” rate of interest constant.
Around one quarter of gilts are also linked directly to a measure of inflation – the retail price index (RPI) – which enhances the impact of low inflation on the government’s borrowing costs. Annual consumer price inflation (CPI) was just 0.5 per cent in January according to the Office for National Statistics, although RPI was 1.6 per cent.
“With petrol prices having fallen further since then and the major utility companies having cut gas prices, inflation looks set to turn negative soon,” said economist Paul Hollingsworth from Capital Economics. Hollingsworth believes (CPI) inflation will average just 0.3 per cent this year.
Another reason is the quantitative easing programme in the Eurozone. While the plan is to purchase only Eurozone bonds, they are close substitutes for UK bonds. Investors who sell their Eurozone bonds to the European Central Bank may replace them with UK equivalents.