osbornes gilty pleasure and his triple

Within the financial services industry Chancellor George Osborne is generally applauded for the pig-headed manner in which he has stuck to his austerity drive. Is he about to go too far?

osbornes gilty pleasure and his triple


Elsewhere, opposition politicians have argued he should allow for greater wriggle room in his policies and most of us feeling the pinch probably wish he would have slightly less ambitious spending and deficit reduction targets.

But the negative outlook given to the UK’s AAA credit rating by Fitch last night has left Osborne with even less flexibility in the upcoming Budget.

Fitch joined Moody’s in its decision to hang the UK’s much-coveted (and now rather rare) top-notch rating in the balance and said there was now a slightly greater than 50% chance of a downgrade in the next two years.

In its supporting statement Fitch said it expected the upcoming Budget to reaffirm the government’s commitment to deficit reduction, with permanent reductions in current spending and structural reform to public services and welfare.

A simple way for Osborne to reduce the deficit is to keep borrowing costs subdued and ensure nominal GDP growth and inflation remain higher.

The motivation for his madness

This is surely the rationale behind his proposal for a 100-year gilt, although it is a little more difficult to work out his motivation.

Is he trying to lock-in historically low borrowing costs because he knows the AAA is at risk and borrowing costs will rise if the UK is downgraded? Or, is he trying to save the UK’s top credit rating accolade by allowing inflation and GDP to outgrow borrowing?

Most likely it is a combination of both. But one thing is for certain, Osborne did not have the investor in mind when he proposed the 100-year and/or perpetual bonds.

Mike Turner, head of strategy and asset allocation at Aberdeen Asset Management, says: "Unless you think the interest rate environment is going to be conducive towards bond yields falling, why on earth would you want to buy something that you do not get your capital back for 100 years or ad infinitum?

"The government is right to secure low interest rates, but I think jumping out to 100 years is a bit excessive, who knows what is going to happen over the next century. There would be times it would look a good investment and times it would not be."

Even pension funds which look over a much longer time horizon have come out saying the 100-year gilts don’t sound attractive.

Financial repression

Another idea that has been mooted is Rogoff and Reinhart’s theory of financial repression, which says following a period of high indebtedness the government will keep interest rates and yields unnaturally subdued even if that means savers and investors suffer.

Turner says: "This is likely to be one method of the government getting out of its indebtedness, so why would you want to be the one lending the money? Financial repression is exactly what is going on here."

Osborne has made much out of the safe haven status of gilts, but a sovereign bond is only a safe as its next credit rating.

"International investors might find the AAA more stable, but it is also to do with currency denomination, they want to be invested in currency that will (probably) stay around," Turner says.

The Bank of England’s quantitative easing programme has also kept gilt yields low by propping up demand – by the end of the current round it will own 30% of the gilt market. Finally, pension funds are using swaps and futures to invest in gilts as a method of interest rate hedging.

"The gilt market is not demanded by returns maximisers," says Turner, "It is demanded by people reducing risk and who will give up potential returns in order to do that," says Turner, "The chancellor is being a little bit disingenuous by saying the low yields on gilts currently is down to the UK’s safe haven status, but that’s not to say he should not take advantage of it."

Osborne definitely has no qualms on that front.

What do you think about the 100-year gilts, would you buy any? Do you think too much stock is put on the UK’s credit rating? Let us know below.



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