Part of the reason why gilt yields are so low, of course, is the credibility of the fiscal consolidation, but in a sense that’s an old story.
The bulk of the recent move lower in yields has been as a result of safe haven flows and, with the eurozone in turmoil, these are unlikely to vanish quickly. For better or worse, the UK is viewed as a sovereign state, with its own central bank, issuing debt in its own currency and with no record of default. For many investors, this is still an attractive proposition in an uncertain world.
In short, there is some limited room for a temporary easing in the fiscal squeeze without spooking the markets. Indeed with the economic data so soft, markets may actually welcome the boost to economic activity: the debt burden will not fall unless the economy grows.
The Office for Budget Responsibility would have to take into account the lower cost of funding plus the boost to economic activity, when assessing how any such change might affect the dual fiscal mandate, mindful that the main fiscal rule refers to current rather than capital spending.
Resurrecting a more generous school refurbishment programme and other infrastructure projects seem obvious candidates for the temporary fiscal boost. This would involve some loss of face on the part of the coalition and an implicit acceptance of the too-much-too-soon argument from Labour, although mid-term governments are generally unpopular anyway, so best take it on the chin.
