Not gilt-y bond markets force Brown to back down

The PM has admitted there can be no more fiscal stimulus in the budget, after yesterday's gilts auction flop.

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Last Updated: 31 Aug 2010

It’s a humiliating turn round for Brown, who started the week drumming up support for globally-agreed action ahead of next week’s G20 but is now having (tacitly at least) to own up to the fact that we can’t afford to do any such thing.

Why not? Well, for the first time in seven years, an auction of UK government bonds – called gilts because back in the day the Bank of England’s bond certificates were gilt-edged -  failed to sell out yesterday. A mere 93% of the £1.75bn of bonds issued found buyers, which might sound like a good result for any sale in these straitened times but by the standards of the bond market it’s a serious failure. One of the worst on record in fact.

The normally stable, quiet and boring bond market is often regarded as the less exciting cousin of the stockmarket, but in many ways it is more fundamental to the state of public finances because it’s on the bond market that government’s borrow money. Thus the state’s ability to keep on spending in times of economic hardship such as these depends on its ability to keep borrowing by issuing gilts.

Auctions such as yesterday’s are typically oversubscribed to the tune of two to one because government debt is regarded as one of the safest bets around. So the failure to get the issue away can be seen as a vote of no confidence in the nation’s public finances. Why? Well, the state of the pound makes UK debt much less attractive to foreign investors, further compounded by the prospect of inflation returning hinted at by the unexpected rise in CPI earlier this week. There are also more general concerns that the government is in danger of simply borrowoing too much, a position even normally reticent Bank of England Governor Mervyn King publicly espoused yesterday.

If investors won’t buy the gilts, then the government doesn’t get its money - it’s the national equivalent of running up against your credit card limit. In which case the government is faced with the urgent need to balance the books - either by instigaing abrupt and painful cuts in public spending and increases in taxation, or dusting off the begging bowl and going cap-in-hand to the IMF for a handout.

There are some mitigating circumstances, mostly based around the effects of quantitative easing. The Bank has been busy buying up its own bonds as a result of the QE process, but the bonds which were up for sale yesterday – so called long bonds due to mature in 40 years - don’t qualify, making them a lot less attractive. It may also be that King’s warning put the frighteners on prospective buyers.

But even so, it’s hard to see the situation in anything but a pretty dismal light, as Brown’s abrupt volte-face shows only too well. If any more such auctions of gevernment debt fail, then the economy will well and truly have hit the buffers.

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