Banging on about gilts, again
August's borrowing numbers were worse than forecast and the gilt market did not care. Yields are following the oil price and US Treasuries. If investors really were losing faith in the UK, the pound would be the first place to look, and it is well above its 2022 low.
First published in Noise Cancelling
Churchill's advice for hard times was to “keep buggering on”, and on the subject of gilt yields, I intend to. Yesterday, the ONS reported that the government borrowed £18.3bn in August, £3.5bn more than the OBR expected. Within hours the ten-year gilt yield had fallen below 5.2%. By the afternoon it was higher again, and the borrowing figures had nothing to do with either move. The oil price did, as it has for weeks, and that is what most commentary is still missing.
The subject, of course, is government borrowing, which has once again captured the headlines following the release of August's government borrowing data. Today’s release shows that, year on year, borrowing rose by nearly 20% to £18.3bn. The outturn is some £3.5bn higher than the OBR's March forecast, and £8.1bn higher than its forecast for the first five months of this tax year.
Although this five-month total is £2.2bn below the same period last year, it still makes for depressing reading, reflecting, unsurprisingly, higher-than-expected central government spending on social benefits and higher debt interest.
Interestingly, reflecting better underlying economic activity than the OBR had forecast, central government tax receipts for the year to date are £1.1bn above the OBR's March forecast, reflecting higher corporation tax, PAYE and NIC receipts (something I am not surprised by).
The simple conclusion, and the one I have been wittering on about for over two years, is that this government is anything but fiscally disciplined, as the Chancellor has claimed; it is in fact fiscally incontinent and appears incapable and unwilling, as Andy Haldane said only last week, to cut public spending.
But what about the higher debt interest payments? Are these the product of investors becoming concerned about the scale of government borrowing, as the media would have us believe, and if so, are we approaching the limit of what markets will tolerate, as many have also suggested?
There is a limit. We are not near it
Here I must part company with consensus, because it is simply not true that high gilt yields are the product of this worrying fiscal incontinence, which is something I have argued in several recent NC pieces.
The data points unequivocally to different causes that the UK government does not control and never will. The point I am making here is subtle but important. I am not suggesting that there is no limit to the market's tolerance for fiscal profligacy. Clearly there is, and there are countless examples of this in recent history, from the Weimar Republic in the last century to Argentina in this. Indeed, Britain in the 1970s under a Callaghan and Healey-led government might be an even more apt example, when the deficit approached 6.3% of GDP with inflation at 27% and ten-year yields at 15%.
The subtle but important point here is that the UK is nowhere near that point of distress. We may not like the fact that public debt is high, along with the interest burden, or that the government's spending is excessive, as are taxes, but the suggestion that we are collectively at the limit of what markets will tolerate is not supported by contemporary reality or by data.
By the way, the fact that we are not at the limit is an entirely good thing because, rather obviously, if a country with a free-floating currency gets anywhere near it, then all hell breaks loose.
Follow the oil price
High gilt yields are a product of elevated inflation, following the war in the Gulf and its impact on energy prices, and the close relationship between UK ten-year yields and those prevailing in the US. Both markets have in the past few weeks moved in lockstep with the oil price (as a proxy for inflation) as it moved up to nearly $110 a barrel and then retreated to $100.
Indeed today, despite the worse-than-expected borrowing data, gilt yields fell below 5.2% because the oil price was down below $100. Yesterday afternoon, gilt yields rose again because the oil price has reversed that fall and is now back above $100.
It's pretty clear to me, and should be to anyone paying attention, that the disappointing borrowing data had no impact at all on the market.
Gilts go where Treasuries go
Brent, back to $100
Ask the pound
One further point is one I have just hinted at. If there was genuine distress in the gilt market, it would also be obvious in the currency market. In other words, if there was some kind of simmering crisis in the gilt market where investors' confidence was shredded, as the media might have us believe, this would be reflected in a weak and falling pound. And yet, over the last four years the pound has appreciated by about 30% against the US dollar.
The pound is not behaving like a currency in crisis
Since the low in 2022 following the outbreak of war in Ukraine, sterling has recovered significantly against the US dollar. Given that the level of the currency is probably the best proxy for confidence in a nation's financeability (I can think of no better), the last four years disprove the hypothesis that there is a growing risk premium in gilts. One might argue, based on this 30% appreciation, that the risk premium attaching to the UK has actually diminished.
The gilt premium is below its forty-year average
Summary
The point I am making is subtle but important. I do not claim that the UK is a paragon of fiscal probity. Far from it. In fact, as I have argued on numerous recent occasions, the incumbent government is spending far too much of other people's money, and by raising taxes excessively to pay for that fiscal incontinence, it is damaging the economy and constraining its growth potential. Unlike Mr Burnham and Mr Healey and their forebears, I do not believe the state is an efficient allocator of resources. In fact, history shows that whenever the state becomes bloated, as it is in the UK, employment, living standards, wealth creation and the economy in general all suffer, just as they are now.
But crucially, all is not lost. The UK, unlike its nearest geographic neighbour, is financeable, and confidence in its currency and financial markets shows that. Going forward, despite the damage inflicted on the economy by this administration, I am confident that it comes good over the next two years (it already is), which, I believe, will be characterised by lower inflation, lower interest rates, lower gilt yields, less debt interest, better productivity and better growth outcomes. It really could be rather good!
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