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Global banks shun UK Gilts on 'stagflation' risk
A clutch of global banks and funds have warned clients to steer clear of UK Gilts, fearing that the Bank of England has opened the door to “stagflation” and risks losing credibility.
Nomura said the Bank of England's refusal to check inflation running at 2.7pc validates suspicions that it is 'actively seeking to inflate away debt' Photo: Getty Images
By Ambrose Evans-Pritchard
7:05PM GMT 20 Feb 2013
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“Systematically forecasting a disinflation that never materialises has exposed the bank to ridicule,” said Nomura, Japan’s biggest lender and a conduit for Asian investors.
Nomura said the Bank’s refusal to check inflation running at 2.7pc validates suspicions that it is “actively seeking to inflate away debts. It seems the Bank of England may be taking the dubious path of ignoring stated targets when they prove problematic. Markets are becoming less forgiving,” it said.
Nomura warned that the recent mix of rising Gilt yields and a slump in sterling is a “disturbing” sign, adding that British debt auctions may have to be watched as closely as Club Med bond markets during the European debt crisis.
The risk is that a toxic 1970s mix of low growth and rising inflation will take hold, setting off a “tremendous” rise in long-term yields as markets adjust to a new era of “stagflation”. The Japanese bank advised clients to pay “close attention” to fiscal strategy laid out in the Budget on March 20.
Simon Ward from Henderson Global Investors said growth of Britain’s broad money supply (M4ex) has accelerated to 5.2pc and “velocity” is rising, an inflationary brew. “I’m worried that velocity could shift violently upwards if the Bank gets any more dovish. I am not keen on bond markets globally but Gilts look one of the worst,” he said.
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Rene Defossez from France’s Natixis said Britain looks vulnerable on multiple fronts, not helped by talk of European Union exit. Public debt will reach 110pc of GDP by 2016. The current account deficit is deteriorating. The country is stuck in a vicious circle as a high “fiscal multiplier” prevents budget cuts from making a dent on the deficit.
Mr Defossez said it is no coincidence that Britain is leading the global debate on “real monetisation” of sovereign debt. He warned that the surge in implied inflation on 10-year index-linked Gilts from 2.4pc to 3.2pc since July is a warning that expectations are becoming unhinged. “British assets could suffer seriously,” he said.
Philip Poole from HSBC said the unique circumstances that made Gilts a safe-haven during the EMU crisis are fading. Foreigners are unlikely to add further to their £400bn stock of UK bonds, and may rotate into EMU debt where there is less risk of currency erosion. The jump in Gilt supply from £51bn in 2012 to £84bn this year will ratchet up the pressure.
Ultimately, the Bank of England can cap Gilt yields by boosting its purchases beyond £375bn – already 30pc of UK public debt – but only at the risk of letting the inflation genie out of the box. “The critical moment has arrived when the Bank can no longer act as a back-stop for the Gilt market,” said Mr Ward.
A clutch of global banks and funds have warned clients to steer clear of UK Gilts, fearing that the Bank of England has opened the door to “stagflation” and risks losing credibility.
Nomura said the Bank of England's refusal to check inflation running at 2.7pc validates suspicions that it is 'actively seeking to inflate away debt' Photo: Getty Images By Ambrose Evans-Pritchard
7:05PM GMT 20 Feb 2013
12 Comments “Systematically forecasting a disinflation that never materialises has exposed the bank to ridicule,” said Nomura, Japan’s biggest lender and a conduit for Asian investors.
Nomura said the Bank’s refusal to check inflation running at 2.7pc validates suspicions that it is “actively seeking to inflate away debts. It seems the Bank of England may be taking the dubious path of ignoring stated targets when they prove problematic. Markets are becoming less forgiving,” it said.
Nomura warned that the recent mix of rising Gilt yields and a slump in sterling is a “disturbing” sign, adding that British debt auctions may have to be watched as closely as Club Med bond markets during the European debt crisis.
The risk is that a toxic 1970s mix of low growth and rising inflation will take hold, setting off a “tremendous” rise in long-term yields as markets adjust to a new era of “stagflation”. The Japanese bank advised clients to pay “close attention” to fiscal strategy laid out in the Budget on March 20.
Simon Ward from Henderson Global Investors said growth of Britain’s broad money supply (M4ex) has accelerated to 5.2pc and “velocity” is rising, an inflationary brew. “I’m worried that velocity could shift violently upwards if the Bank gets any more dovish. I am not keen on bond markets globally but Gilts look one of the worst,” he said.
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20 Feb 2013
Rene Defossez from France’s Natixis said Britain looks vulnerable on multiple fronts, not helped by talk of European Union exit. Public debt will reach 110pc of GDP by 2016. The current account deficit is deteriorating. The country is stuck in a vicious circle as a high “fiscal multiplier” prevents budget cuts from making a dent on the deficit.
Mr Defossez said it is no coincidence that Britain is leading the global debate on “real monetisation” of sovereign debt. He warned that the surge in implied inflation on 10-year index-linked Gilts from 2.4pc to 3.2pc since July is a warning that expectations are becoming unhinged. “British assets could suffer seriously,” he said.
Philip Poole from HSBC said the unique circumstances that made Gilts a safe-haven during the EMU crisis are fading. Foreigners are unlikely to add further to their £400bn stock of UK bonds, and may rotate into EMU debt where there is less risk of currency erosion. The jump in Gilt supply from £51bn in 2012 to £84bn this year will ratchet up the pressure.
Ultimately, the Bank of England can cap Gilt yields by boosting its purchases beyond £375bn – already 30pc of UK public debt – but only at the risk of letting the inflation genie out of the box. “The critical moment has arrived when the Bank can no longer act as a back-stop for the Gilt market,” said Mr Ward.
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