FT Alphaville highlights a near 50-year low in 10-year gilts and puts the blame for this fall squarely at the feet of bearish comments from new MPC member Martin Weale in the Times:
'It would be “foolish” to rule out the possibility of a double-dip downturn, even if it was not the Bank’s central prediction, said Dr Martin Weale, the newest member of the Monetary Policy Committee (MPC). He also feared that the Bank’s central outlook — which is for growth of about 2.8 per cent in 2011 and 3.2 per cent in 2012 — could be too optimistic…
Dr Weale said that the Bank’s latest economic forecasts, published on August 11, had a 10 per cent outside chance of four-quarter long economic contractions in 2011 and 2013. “The forecast is putting a significant chance on the economy contracting over a four-quarter period,” said Dr Weale.'
The link between Weale's bearish-ness and the drop in gilt yields raises questions about what effect yields will have on business investment (remember - the Chancellor and the OBR are staking their reputations on fiscal restraint lowering 10-yr yields and so helping to encourage business investment).
So what's pushing 10-yr yields close to record lows?
Well three factors: global risk, domestic weakness and fiscal consolidation.
Let's breifly take those in turn.
1. Global risk. With the global recovery stumbling and sovereign default still a moderate risk, investors are seeking safety in the arms of US, UK and German government bonds. As demand for these longer-term bonds goes up, so does their price, pushing down the yield. So far, so good. The problem is the affect on business investment. If financial markets are shunning risk, then its because there's something worrying about the state of the global economy. Concerns about the global recovery makes businesses uncertain - and that's why most are sitting on piles of cash and holding off on investment.
2. Domestic (UK) risk. Well, a weak economy typically favours bonds as investors move out of relatively riskier equities in favour of relatively safer goverment bonds. This is the sentiment behind the Weale-driven dip in yields. But yet again, domestic weakness will make businesses cautious about investing.
3. Fiscal consolidation. I'll put this upfront so there is no second guessing our views: this isn't a 'deficit denier' arguement. There is a deficit, it needed to be tackled and EEF supports most of the government fiscal consolidation plans. And tackling the structural deficit will provide downward pressure on gilt yields (or at the very least limit any upward pressure). The question we're raising about the affect on investment. The government is making a 'crowding out arguement' that says shrinking the deficit will lower rates and boost private sector investment. Not only is this arguement weak - all interest rates were low prior to the recession, which was part of the problem behind the financial crisis, so there's only a weak case for the government to make. Add on top the uncertainty caused by their unnecessarily deep capital spending cuts, and you've got businesses being cautious about investment because they've got concerns about their public sector-related orders.
So in reality, two of the three drivers pushing gilt yields down will naturally imply only limited growth in business investment. And the government's gamble on fiscal consolidation boosting investment actually cuts both way, providing an uncertain benefit.