Westminster Blog

The yield on UK 1o-year gilts fell yesterday to a low of 2.76 per cent – amid huge demand from investors – to its lowest level for half a century.

Its a trend which was hailed by George Osborne’s spokesman as proof that the chancellor’s austerity measures are working, as we reported this morning.

“This is proof that we are now seen as a safe haven, we’re not seeing the increase in yields seen in Europe and the US,” he said.

“It’s a vote of confidence, one of the key aspects of our plan has been a tight fiscal policy combined with a loose monetary policy, it’s the right mix for economic growth, and the need to rebalance towards exports and away from consumption.”

We wrote last September about how low yields meant lower interest repayments on government debts; which could save taxpayers £5-10bn over the course of the Parliament – if yields stay below 3 per cent.

(The current rate has no impact on Britain’s current stock on debt but is likely to mean that the interest payments on new issuance will be cheaper.)

It also means low mortgage rates. The Chelsea Building Society has just brought out the cheapest five-year mortgage rate in history.

There is a flipside, however.

Firstly that people dependent on savings will suffer as rates will fall correspondingly. Also those on certain types of pensions will get less money as annuity rates fall in line with gilt yields.

Secondly, many economists believe that UK gilt rates have not only fallen because of Britain’s economic relative credibility compared to certain eurozone nations and the USA. (Nouriel Roubini has dubbed it “a beauty contest about the least ugly“).

Instead, the low rates also reflect expectations of low economic growth, low inflation and low interest rates for some years to come.

As Samuel Tombs at Capital Economics wrote:

“There are good reasons to think that gilt yields will remain low and may not yet have found a floor….signs that the UK’s economic recovery has ground to a standstill have led markets to revise down their interest rate expectations sharply.”

I had an email exchange last night with Jonathan Portes, director of the National Institute of Economic and Social Research. Portes argues that if low gilt rates were a sign of confidence in Britain then sterling would also have risen sharply; it hasn’t. He offered the following salient point:

It is worth asking whether they (the Treasury) regard Japan’s last ten years of very low long-term interest rates as a “vote of confidence”, and whether they regard achieving Japanese levels of interest rates and growth as a sensible policy objective…

UPDATE: A Treasury aide replies he agrees with the need to avoid a Japan-type situation.

“Japan did what Portes seems to be recommending for the UK, they carried out endless fiscal stimulus packages, never quite dealing with its public finances, racking up massive public debts which was mainly absorbed by its domestic savings market, thus squeezing out productive domestic investment – if the warning is avoid Japan we couldn’t agree more.”

FURTHER UPDATE: Now Paul Krugman has chipped in on his New York Times blog. He argues that the low yields are proof that Osborne’s strategy is going “really, really badly“.