A bond rout could blow a huge hole in the UK’s finances and repeat 1976’s IMF bailout, warns HAMISH MCRAE
The surge in bond yields last week was a global one. But it hit the UK hardest as we have to pay more than any other major economy to fund our debt.
The yield – or effective interest rate – on ten-year gilts (UK Government bonds) was just over 5.1 per cent on Monday.
By Thursday evening in trading in New York it had shot up to 5.4 per cent, before coming back a bit on Friday.
If you want to know what that means for the rest of us, mortgage rates have already started to climb again. The average five-year fix is 5.71 per cent.
What is happening is one more twist in a continuing and troubling story – continuing because we almost certainly have a long path of high interest rates ahead of us, troubling because governments, especially our own, have zero understanding of what is going to hit them.
So, how long will bond yields keep on rising? And how high will they go?
Government borrowing costs have shot up just as John Healey is planning his Budget
We are six years into the current bear market, for in terms of yields the bottom was in 2020, when ten-year gilts yielded just 0.25 per cent.
That seems amazing now, and it’s even more amazing to think that people (or rather banking institutions) bought German government bonds at negative yields. You had to pay to lend the government money.
I can’t see this upward trend in yields reversing until some cathartic event – a global recession, or maybe another surge in inflation, or perhaps both – forces the world’s central banks to whack up interest rates far beyond today’s level. Either way, it will not be fun.
What’s easier to gauge is what the normal range of yields is likely to be over the next decade and beyond.
We are back to some sort of normality, with yields giving investors a small return above inflation, but is that return high enough? History helps a bit.
Go back to the 19th Century when there was no inflation: prices in 1900 were actually lower than in 1800. For most of that time the nominal yield for gilts ranged from 2.5 to 4.5 per cent. Since there was no inflation that was the real yield too.
Chris Watling at consultancy Longview Economics said last week that if you add the central bank inflation target of 2 per cent, you get 4.5 to 6.5 per cent.
So we are in the middle of that historic range, or rather would be were the central banks doing their job.
Since they are not, with the markets expecting inflation averaging at least 3 per cent over the next decade, the range is more like 5.5 to 7.5 per cent.
It looks like the UK’s national debt passed £3 trillion in August, for it was £2,985 billion in July – we get the update next week.
Debt interest is already more than £110 billion a year, the third largest chunk of public spending after social security (which includes pensions) and the NHS.
If ten-year gilts go to 7 per cent, which is perfectly possible, that would blow a huge hole in the Government’s tattered finances.
It gets worse. A quarter of our national debt is linked to the Retail Prices Index, which is usually higher than the Consumer Prices Index measure of inflation.
So on my quick tally, that bill of £110 billion could go up to £140 billion or £150 billion by 2030.
This can’t go on. Other countries have similar problems, and in some cases, including the US, the numbers look even more terrifying. It was a surge in US bond yields last week that helped push up ours to such an extent.
But the situation is worse for the UK because our Government has such a bad reputation among potential investors.
It all feels uncomfortably like the autumn of 1976, 50 years ago, when another Chancellor called Healey, Denis Healey, faced a run on the pound and had to apply for a bailout from the International Monetary Fund.
He famously turned back at Heathrow to calm the markets instead of going to the IMF meeting in the Philippines – an event I well remember as I was on that plane heading out to report on the meeting.
So what will happen?
We cannot see the detail, but remember that exchange between Bill Gorton and Mike Campbell in Ernest Hemingway’s novel The Sun Also Rises: ‘How did you go bankrupt?’ Bill asks. ‘Two ways,’ Mike says. ‘Gradually and then suddenly.’
