Home Business NewsBusiness Why Bond vigilantes are Rishi’s big problem

Why Bond vigilantes are Rishi’s big problem

by LLB Editor
4th Mar 21 11:30 am

The OBR estimates the Chancellor would face an extra £20.8 billion of debt interest in 2025/26, if interest rates were 1% higher.

That would wipe out the benefit of freezing income tax allowances, and a big chunk of the corporation tax rise too.

The rate at which the government can borrow money over 10 years has risen to 0.8%, from 0.2% at the beginning of the year, as inflation concerns are building.

The Bank of England, pension funds and insurance companies might bail the Chancellor out.

Laith Khalaf, financial analyst at AJ Bell, comments: “Heavily indebted Chancellors would normally welcome a nice dose of inflation to whittle away their borrowing, but rising prices are a double-edged sword in today’s climate of ultra-low interest rates. That’s because inflation concerns have been bumping up the cost of government debt this year, and could yet blow a hole in the Chancellor’s best laid plans.

“The government was able borrow money for 10 years at just 0.2% at the beginning of this year, and that’s now risen to 0.8%, as markets are pricing in an economic reflation on the back of the vaccine roll out. That’s still an incredibly low cost to borrow, but the OBR reckons that if interest rates were 1% higher, that would add £20.8 billion to the government’s debt interest bill in 2025/26. To put that in context, that would wipe out all the £8.2 billion gain the Treasury expects from freezing income tax allowances, as well as a sizeable chunk of the £17.2 billion projected to roll in from the rise in corporation tax.

“Inflation is a dog that hasn’t barked despite huge monetary stimulus over the last twelve years, and the fears we’re seeing in the market today could well fizzle out before raising government bond yields much higher. But the numbers from the OBR do highlight how vulnerable the Exchequer is to a bond market sell-off, and the bond vigilantes, who might decide they want a bit more return to lend to the Treasury in future. As James Carville, an aide to President Clinton, famously said in 1994, he’d quite like to be reincarnated as the bond market, because then you could “intimidate everybody”.

“The good news for the Chancellor is that there are plenty of fairly price-insensitive bond buyers out there, such as pension funds, insurance companies, and funds which simply want to limit volatility. The Bank of England is another buyer of government debt through its £875 billion QE gilt purchase programme. The Treasury is effectively paying bank base rate of 0.1% on this massive chunk of QE debt, again a sign of its susceptibility to interest rate rises.


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