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Home Opinion TorFX - Jon Beddell Blog TorFX: Expecting gilt yields to rise
TorFX: Expecting gilt yields to rise PDF Print E-mail
Written by Jon Beddell   
Monday, 11 January 2010 11:01
At some point the bank will have to draw a line and allow gilt yields to rise to market levels
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Many of us will have consumed a fair amount of liquid over the festive period.  

It's nice to oil the wheels of the party season, but there's always the dreaded New Year withdrawal of, well, all the nice stuff you were binging on over Christmas!  

The trouble with resolutions is that you set goals which almost always consist of consuming less of something that you have become used to, in some cases dependent on.  Cigarettes, alcohol and chocolate sales must fall through the floor in January.  The upside is that you get to replace those lost pleasures with something that should make you feel good.  Exercise, better diet and feeling noble about your new found abstinence.

 For around a year now, following a brief period of almost total starvation when the credit crunch took hold in late 2008, financial markets have been indulging in a binge of liquidity.  

If the world economy is the fat puppy, then central banks are most definitely her feeder.  Internet Oracle Wikipedia defines quantitative easing as "an extreme form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero".  

Given the immense media coverage over the last year my one year old understands that much.  Desperate times call for desperate measures, but what's in store in 2010 when central banks start to wean the economy off this saccharine induced high?  Markets are in broad agreement that we in the UK are the most vulnerable to the dangers of excessive QE, causing many to predict that our burgeoning budget deficit will likely trigger a credit downgrade during the year.
 
The real risk of QE is that of increasing inflation, or in extreme cases hyper inflation as too much money floods the system, devaluing the currency unit.  On the other hand, stopping too soon could derail a fragile recovery.  

While the US and Europe are talking about "exit strategies", the Bank of England have so far given no indication as to what the next move will be once the current allocation of £200bn has been used up (probably by the end of January).  At some point the bank will have to draw a line and allow gilt yields to rise to market levels (under QE the BoE print new money "from thin air" to buy up gilts, keeping yields subdued and money rolling in to government coffers).  

The only comparisons to be drawn are with Greece, who have to pay investors 2.5% more for their government debt than Germany does for theirs.  The current premium of gilts over German bunds is around 0.75%.  If that rises substantially once QE is withdrawn it will compound our budget deficit, which could in turn cause a credit downgrade (there is talk of a downgrade for Greece right now) and loss of confidence in the pound.
 
In a global context, you could be forgiven for thinking that the stock market rally that began in March 2009 has been largely fueled by the temporary sticking plaster of QE, and that once that ends, the real picture will emerge.  

Unfortunately, there is no feeling noble about stricken financial markets.  It's possible, just possible that enough has been done to create self sustaining growth in the years to come, but the next key event here in the UK will be what the BoE do in the next few weeks.  Extend the party season for another few months, or start the New Year with a resolution?
 
Last Updated ( Monday, 11 January 2010 11:03 )
 

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