ICAEW chart of the week: Government bond yields

11 December 2020: Ultra-low or negative yields provide governments with an opportunity to borrow extremely cheaply, but what will happen if and when interest rates rise?

Government 10-year bond yields

Germany -0.61%, Switzerland -0.59%, Netherlands -0.53%, France -0.36%, Portugal -0.02%, Japan +0.01%, Spain +0.02%, UK +0.26%, Italy +0.58%, Greece +0.60%, Canada +0.76%, New Zealand +0.91%, USA +0.95%, Australia +1.02%

On 9 December, the benchmark ten-year government bond yield for major western economies ranged from -0.61% for investors in German Bunds through to 0.95% for US Treasury Bonds and 1.02% for Australia Government Bonds, as illustrated in the #icaewchartoftheweek.

One of the more astonishing developments of the last decade or so has been the arrival of an era of ultra-low or negative interest rates, even as governments have borrowed massive sums of money to finance their activities. This is not only a consequence of weak economic conditions and the slowing of productivity-led growth, but it has also been driven by the monetary policy actions of central banks through quantitative easing operations that have driven down yields by buying long-term fixed interest rate government bonds in exchange for short-term variable rate central bank deposits.

For bond investors this has been a wild ride, with the value of existing bonds sky-rocketing as central banks have come calling to buy a proportion of their holdings, crystallising their gains. The downside is the extremely low yields available to debt investors on fresh purchases of government bonds, which in some cases involve paying governments for the privilege of doing so.

Yields vary according to maturity, with yields on UK gilts ranging from -0.08% on two-year gilts through to 0.26% for 10-year gilts (as shown in the chart) up to 0.81% on 30-year gilts. In practice, the UK issues debt with an average maturity between 15 and 20 years, so the current average cost of its financing is higher than that shown in the chart at between 0.48% and 0.77% being the yields on 15-year and 20-year gilts respectively. This has the benefit of locking in low interest rates for longer, in contrast with most of the other countries shown that tend to issue debt with an average maturity of less than ten years.

Quantitative easing complicates the picture, as by repurchasing a significant proportion of government debt and swapping it for central bank deposits, central banks have reversed the security of fixed interest rates locked in to maturity with a variable rate exposure that will hit the interest line immediately if rates change. 

In theory, this should not be a problem, as higher interest rates are most likely to accompany stronger economic growth and hence higher tax revenues with which to pay the resultant higher debt interest bills, but in practice treasury ministers are not so sanguine. In leveraging public balance sheets to finance their responses to COVID-19 – on top of the legacy of debt from the financial crisis – governments have significantly increased their exposure to movements in interest rates, just as other fiscal challenges are growing more pressing.

Expect to hear a lot more over the coming decade about the resilience of public finances as governments seek to reduce gearing and reduce their vulnerability to the next unexpected crisis, whenever that may occur.

This chart was originally published on the ICAEW website.

ICAEW chart of the week: borrowing to exceed half a trillion pounds

29 May 2020: Government looks to financial markets to fund large-scale fiscal interventions in the economy.

The #icaewchartoftheweek shines a light on the massive expansion in borrowing being undertaken by the UK Government as it seeks to plug an expanding gap between tax receipts and spending and fund a huge amount of loans to banks and businesses in order to try and keep the economy from collapsing.

At the Spring Budget on 11 March, HM Treasury issued a financial remit to the Debt Management Office and National Savings & Investment amounting to £162bn, comprising £98bn to fund the repayment of existing debts, £55bn to fund a planned shortfall between tax receipts and public spending (the deficit), and £9bn to fund public lending to individuals and businesses.

Since then the fiscal situation has transformed, with the Office for Budget Responsibility (OBR) suggesting that the deficit could increase by as much as £243bn to £298bn in 2020-21, while lending activities could increase by a further £168bn to £177bn. Public sector net debt at 31 March 2021 might increase by £411bn from the Spring Budget forecast of £1,819bn to £2,230bn.

The good news is that the cost of this borrowing is relatively small, with yields on ten-year gilts as low as 0.20%.

To find about more about the global and UK fiscal crisis read the ICAEW Fiscal Insight on coronavirus and public finances.