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So far, so good for British bonds as Brexit storm rages

Updated April 04, 2019

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Britain’s parliament has rejected PM Theresa May’s divorce deal three times and failed to back an alternative, risking a chaotic no-deal Brexit as soon as April 12. ─ Reuters/File
Britain’s parliament has rejected PM Theresa May’s divorce deal three times and failed to back an alternative, risking a chaotic no-deal Brexit as soon as April 12. ─ Reuters/File

LONDON: For all the Brexit tumult, one thing that has remained strong and stable -- to borrow a phrase Prime Minister Theresa May once used to describe her leadership -- is demand for British government debt.

Political crises have pushed up borrowing costs in eurozone countries such as Greece and Italy in recent years.

Britain’s parliament has rejected May’s divorce deal three times and failed to back an alternative, risking a chaotic no-deal Brexit as soon as April 12, although May on Tuesday announced cross-party talks to break the impasse.

But interest rates on Britain’s roughly 1.5 trillion pounds ($2.0tr) of government bonds, known as gilts, have fallen.

The main reason is that gilts, representing one of the world’s major government bond markets, are influenced mostly by the ebbs and flows of the global economy and financial markets.

But other factors are at work too.

Below is a look at some of the reasons for the strong demand for gilts in the face of Britain’s political chaos.

Global slowdown

The central banks of the US and the eurozone recently rowed back on their plans to remove the stimulus they have been providing since the global financial crisis, reflecting worries about a slowdown in the global economy.

This has been a major factor in driving gilt yields lower and they have fallen this year in step with the Group of Seven rich countries.

Last week the 10-year gilt yield fell below one per cent for the first time in 18 months, although it rebounded to 1.07pc on Wednesday as investors judged May’s plan likely to cut no-deal Brexit risk.

Still a safe haven

British government bonds retain high credit ratings even after losing their top-notch triple-A grades as Britain’s economy and public finances struggled to recover from effects of last decade’s global financial crisis.

Part of gilts’ appeal is Britain’s track record, stretching back hundreds of years, of not defaulting on its debt, bolstered by the fact it issues its own currency.

Domestic ownership

British domestic investors like pension funds and insurance firms, plus the Bank of England, account for the vast majority of gilt holdings, cutting the risk that a sell-off from foreign owners of gilts would wreak havoc in the market.

Foreign owners accounted for 25pc of British government debt securities in 2017, compared with 30pc in Italy and 47pc in France, according to Eurostat data.

Long in the tooth

When a government bond matures, meaning the government repays bondholders what they have lent it; they have an opportunity to move their money elsewhere if they choose.

The average maturity for gilts is much longer than for equivalent European government bonds — another factor that adds to the relative stability of gilts. The average maturity for British bonds is 14.9 years, compared with 7.5 in France, 6.9 in Italy and 6.3 in Germany, according to European Central Bank data.

Brexit effect? Look at the FTSE

Gilts’ current strength also probably reflects the relatively poor performance of the British stock market, which along with the pound has borne the brunt of shifts in investor appetite in response to Brexit developments.

Although the FTSE100 is up 10pc year-to-date, it is vying with Spain’s IBEX as the worst performer among the major European bourses in 2019.

Some of the money that could have sent British stocks higher probably found its way into gilts.

Published in Dawn, April 4th, 2019