The Gilts Thread

[Bloo Loo]

Yes, it is.

Let say (for example) that house prices went up and up andd up, but you had a low, low credit score.

Gues what?

You are homeless. A handful of oligarchs buying stuff at sky high prices while serfs look on without two bob to rub together is certainly possible.

yeah, time to start knitting gloves with no fingers again.

[Godley]

Proud to say 'eee aaaww'.

Latest inflation rates from the back of the Economist:

USA -1.4%

Japan -1.8%

China -1.8%

Canada -0.3%

Euro Area -0.6%

Austria nil

Belgium -1.7%

France -0.7%

Germany -0.5%

Italy nil

Netherlands +0.2%

Spain -1.4%

Denmark +1.0%

Norway +2.2%

Sweden -0.9%

Switzerland -1.2%

Australia +1.5%

HK -0.9%

Malaysia -1.4%

Singapore -0.5%

Taiwan -2.3%

Thailand -7.8%

UK +1.8%

Every significant advanced economy is now in deflation except for the following:

Austria, Italy & Netherlands; all very close and will certainly be dragged down by the other Euro area countries and the idiots at the ECB fighting the last war with their anti-inflation Maginot Line.

Denmark; may survive if they take the radical option of breaking the twenty year policy of shadowing the DM-Euro through the EMU.

Norway; should survive nicely with sensible inflation rate and lots of oil.

Australia; the lucky country will struggle to survive the coming commodity crash.

And the coming commodity crash will set the seal for all those countries just moving into deflation. As input prices collapse; deflation will be locked into their systems.

And the UK? Happy and healthy with historically low inflation bang on target.

Once again I say God bless Badger and Merv for saving us from lost decades of deflation and zero growth.

It will of course take time for the UK to recover from the current recession, growth will be weak for a few years.

But we will have growth.

The EU, the US and Japan will not have growth, deflation does not allow growth.

What a crock of crap argument, your the donkey and duly added to the list.

Stick around fella and tell me what inflation is around the last qtr of this year.

Before then go and find out how 'inflation' is calculated, your numbers are the biggest crock of crap in the shop containing crocks of crap.

'Further, I am making a prediction your are talking 'history' which is exactly where your money is going to be consigned to' said Pooh to Eeyore

[grumpy-old-man-returns]

No I haven't, that thread was regards 'hyper inflation', not 'high' inflation

I have always been in the inflation camp, just not your doomsday scenario's. My cash has now been duly converted into tangibles including a house and land

My opinion has been proved correct to date where as yours? Anyway I thought we were on an amensty, shall I drag up some of your old posts?

We are now entering a new phase of all this where the QE is going beyond it's intial scope, interesting times.

no you haven't

you are the type of poster that jumps on the bandwagon, whenever the bandwagon is proved right.

The majority of posters know this so I don't need to take this any further.

Also, Kagiso is a very intelligent poster fwiw. We only disagree on the final outcome, everything else up to now we have agreed on & that counts for a lot. He is also not a bigheaded poster & does not need to post his virtual worth.

[grumpy-old-man-returns]

Of course the other side of deflation is competitiveness. With other currency zones that impacts on exchange rates if free floating.

The German ppi of -7.8 % yoy announced this morning must surely have the other Eurozone members quaking. They will simply not be able to compete if they don't so something drastic.

& I wonder what that will be.....

ECB emergency meeting to pump more QE in perhaps ?

[Godley]

no you haven't

you are the type of poster that jumps on the bandwagon, whenever the bandwagon is proved right.

The majority of posters know this so I don't need to take this any further.

Also, Kagiso is a very intelligent poster fwiw. We only disagree on the final outcome, everything else up to now we have agreed on & that counts for a lot. He is also not a bigheaded poster & does not need to post his virtual worth.

erm yes I have..........

and in answer to whatever bandwagon is proved right, I bought a house in July and land there seems to be plenty of room on this bandwagon around these parts right now the consensus seems to be that I have bought during a bull trap.............we'll see eh GOM?

[Nationalist]

I've got a question for people who understand gilts.....

What's the relationship between the BoE base rate and the coupon on new gilts?

Commentators keep saying that when QE ends and gilt buyers take fright we will have to increase "interest rates" to make our gilts more attractive and throw in a bit of a risk premium. But is there really any relationship? Can't we keep the BR at 0.5% and let the gilt auctions set whatever rate they set? Gilt yields are already up around 3% and it doesn't seem to have triggered an urge to raise the BR.

That said, if you're getting a new mortgage tomorrow you won't get less than 4.5% so is the BR a complete irrelevence now?

[FreeTrader]

I've got a question for people who understand gilts.....

What's the relationship between the BoE base rate and the coupon on new gilts?

Commentators keep saying that when QE ends and gilt buyers take fright we will have to increase "interest rates" to make our gilts more attractive and throw in a bit of a risk premium. But is there really any relationship? Can't we keep the BR at 0.5% and let the gilt auctions set whatever rate they set? Gilt yields are already up around 3% and it doesn't seem to have triggered an urge to raise the BR.

That said, if you're getting a new mortgage tomorrow you won't get less than 4.5% so is the BR a complete irrelevence now?

It's a complicated question to answer because you start getting into theoretical discussions on what's called the 'term structure of interest rates'. It very much depends on how investors view (for example) the likely path of future changes in the BoE's base rate (Bank Rate), inflation, and government debt issuance.

In general though, today's Bank Rate will heavily influence the yield on short-term gilts, but it will have a lessening effect the further out you go along the yield curve. You can see this in the chart below which compares the UK government liability yield curve in Dec 1989 (when the BoE base rate was nearly 15%) to July 2009 (with the base rate at 0.5%).

I don't think analysts and market commentators are necessarily arguing that if gilt investors take fright the BoE will be forced to raise Bank Rate. They're just saying that the Government will have to offer a higher interest rate on newly-issued gilts to attract investors, and this in turn will tend to raise medium and long term interest rates throughout the economy (including mortgage rates).

I think it would be overdoing it to say that BR is an irrelevance now, but it's certainly a far less effective tool in times of financial crisis when lending institutions become capital constrained.

[lufc]

I suspect what the BoE knows is that the government commitments made to the UK banking sector are so great (and are likely to result in such enormous losses to the taxpayer) that there will be no choice but to monetise the liability.

Rather than do it later when the true cost becomes apparent, it's probably best to print as much you can right now.

The increase in QE was a done deal before the MPC even met.

Interesting stuff FT ... given that the UK banking sector is supposedly in hock to the taxpayer to the tune of £1TR + how much more QE do you think they will have to do before it hits the real economy and becomes properly inflationary ???

Bearing in mind UK QE vs GDP is now running way ahead of the USA JPN & EURO I can't work out why sterling is holding up so well nor why a weak pound is still seen as such a good thing ... we still run a huge trade deficit and that won't just change overnight.

[Nationalist]

It's a complicated question to answer...

Thanks FreeTrader. I think you confirmed what I suspected, ie, that when financial journalists say the government "will be forced to raise interest rates" they are being rather simplisitic; the govt can offer higher gilt yields without raising rates. TS doesn't HTF until confidence is lost in sterling completely.

[Jekyll]

Does anyone know why it is Bank Rate and not "the" Bank Rate. When did BOE drop definite article?

[FreeTrader]

Public sector net borrowing for July 2009 was £8.0bn, much higher than analysts expected. In addition May and June borrowing were collectively revised upwards by another billion.

Cumulative borrowing for the current fiscal year is now £49.8bn.

There's a dedicated thread here.

Edited August 20, 2009 by FreeTrader

[FreeTrader]

Interesting stuff FT ... given that the UK banking sector is supposedly in hock to the taxpayer to the tune of £1TR + how much more QE do you think they will have to do before it hits the real economy and becomes properly inflationary ???

Bearing in mind UK QE vs GDP is now running way ahead of the USA JPN & EURO I can't work out why sterling is holding up so well nor why a weak pound is still seen as such a good thing ... we still run a huge trade deficit and that won't just change overnight.

The problem is that it won't necessarily become inflationary in the sense that you mean i.e. manifest itself in higher CPI inflation. The BoE is using exactly the same philosophy that got us into this mess (encouraging GDP growth through asset inflation), and if you compare the latest MPC minutes with those of the Federal Reserve in 2001/02 you'll see a scary similarity.

Like you I think that CPI will spike at the start of next year, but it's pretty clear that BoE is going to waive this aside as a temporary blip due to technical factors. How the markets react will be interesting, but at present there doesn't seem to be a great deal of concern.

[Ash4781]

Do they at least need to increase Qe by what they expect it to come in at over the 175bn budget forecast ?

[yellerkat]

A bit of a floppy gilt auction - FT Alphaville.

Oopsy daisy - Thursday saw another lacklustre gilt sale from the UK Debt Management Office.

This time it came in the form of a 2032 index-linked issue, the sale of which was only 1.75 times covered.

Quoting Marc Ostwald at Monument Securities

Methinks the call is “Gentlemen of the rating agencies, time to load your downgrade guns!!â€

[Ash4781]

http://www.telegraph.co.uk/finance/finance...mpaign-use.html

The suits at Japan's Finance Ministry have called in the advertising gurus to help drum up some interest in the country's bonds. With the recession forcing national debt up to 684.4 trillion yen (£4.41 trillion), there's no shortage of supply.

The Japanese will soon find the adverts in taxis and on their television screens. Who knows whether the Japanese will pay any attention but there's a department in Whitehall that may be paying close interest.

After all, the Chancellor of the Exchqeuer, Alistair Darling, has a record £220bn worth of British government debt to find a home for this year. Fast forward 12 months and it may be George Osborne, the shadow chancellor, with the same headache.

We don't know whether Mr Darling has yet picked up the phone to the brightest (and given the state of the public finances - cheapest) brains in the advertising world.

But if No. 11 Downing Street were to launch an ad campaign to get us all buying Government bonds, what slogan should the campaign use?

[Guest_chris c-t_*]

Found this....

http://www.ft.com/cms/s/0/f112e45c-9199-11...?nclick_check=1

UK short-term bond yields hit all-time lows as expectations intensified that the Bank of England may introduce negative interest rates on its deposits.

Does this mean what I think it means? - negative interest rates on bank reserves? - that would sure increase the money velocity... to infinity - it would be like pass the parcel with the money bomb and if you end up holding the sterling overnight, you pay the BofE?

Also seeing some bad chatter regarding sterling elsewhere today.

EDIT: If this is true it would seem logical that recent gilt prices have been supported by the FEAR of being caught with a large reserve balance if something like this were tried?

Edited August 26, 2009 by chris c-t

[roussell]

Negative deposit rates is the beginning of the end for our financial system. Nobody wants negative Libor rates, who knows where that will lead. Brown has taken away the independence of the BoE and that's not good news, for the country or the currency.

[ccc]

Please get the Tories in ASAP. I know them and the Labour twats are two peas in a pod. However the Tories will have no trouble making tougher decisions if they must.

And they have the luxury of blaming all the pain on 10 years of Labour Rule.

[Jekyll]

Negative deposit rates is the beginning of the end for our financial system. Nobody wants negative Libor rates, who knows where that will lead. Brown has taken away the independence of the BoE and that's not good news, for the country or the currency.

Paying interest on central bank deposits means banks are indifferent between holding reserves at the central bank and investing in gilts (ie both sovereign risk).

If interest on deposits is less than the Bank Rate banks are no longer indifferent and excess reserves will be withdrawn and invested in short-term gilts. If banks had the credit appetite (for which read capital) to invest excess reserves in risky assets then they could have already done so. The closest they have got is ramping up trading operations which are generally less capital consumptive than direct term lending.

So BOE forces banks to hold more gilts which can then be purchased under the QE programme creating more reserves that will be invested in gilts which can then be purchased under the QE programme...

You get the picture.

Of course at this point the whole purpose of paying interest on central bank reserves is defeated. The central bank lent directly into the banking system to replace the disfunctional money markets. Reserves held at the central bank provided the liqudity banks needed to roll short-term inter-bank obligations. Stopping paying this interest, without reversing the QE, forces that liquidity out into the open, specifically into the gilts market (and probably bank trading books in general too).

Given this, it seems to me cutting rates on reserves to below the target Bank Rate would only be countenanced if the money markets are now properly functioning. But it is hard to see why it is necessary other than as a debt monetisation exercise.

[Guest_chris c-t_*]

Paying interest on central bank deposits means banks are indifferent between holding reserves at the central bank and investing in gilts (ie both sovereign risk).

If interest on deposits is less than the Bank Rate banks are no longer indifferent and excess reserves will be withdrawn and invested in short-term gilts. If banks had the credit appetite (for which read capital) to invest excess reserves in risky assets then they could have already done so. The closest they have got is ramping up trading operations which are generally less capital consumptive than direct term lending.

So BOE forces banks to hold more gilts which can then be purchased under the QE programme creating more reserves that will be invested in gilts which can then be purchased under the QE programme...

You get the picture.

Of course at this point the whole purpose of paying interest on central bank reserves is defeated. The central bank lent directly into the banking system to replace the disfunctional money markets. Reserves held at the central bank provided the liqudity banks needed to roll short-term inter-bank obligations. Stopping paying this interest, without reversing the QE, forces that liquidity out into the open, specifically into the gilts market (and probably bank trading books in general too).

Given this, it seems to me cutting rates on reserves to below the target Bank Rate would only be countenanced if the money markets are now properly functioning. But it is hard to see why it is necessary other than as a debt monetisation exercise.

but...but...but... we're talking about the BofE charging to hold deposits; i.e. a negative interest rate (not a negative real rate, but a true negative rate!!). I think we're into new territory if we QE and then charge for that extra money to be held and not lent. Banks must look to utilise that capital; or maybe just move it out of sterling.

I agree that it is looking like a debt monetization exercise if they do go ahead with it. Reserves have grown from £30bn to £150bn over the last year, and if that is re-lent then we're talking fractional reserve money multiplier up to ~£1 Trillion of extra credit being forced into the system.

EDIT to add:

Stopping paying this interest, without reversing the QE, forces that liquidity out into the open, specifically into the gilts market (and probably bank trading books in general too).

here, I agree... it forces the liquidity out into the open.. and if they start charging for deposits held at the BofE...? capital flight??

Edited August 26, 2009 by chris c-t

[Jekyll]

but...but...but... we're talking about the BofE charging to hold deposits; i.e. a negative interest rate (not a negative real rate, but a true negative rate!!). I think we're into new territory if we QE and then charge for that extra money to be held and not lent. Banks must look to utilise that capital; or maybe just move it out of sterling.

I agree that it is looking like a debt monetization exercise if they do go ahead with it. Reserves have grown from ?30bn to ?150bn over the last year, and if that is re-lent then we're talking fractional reserve money multiplier up to ~?1 Trillion of extra credit being forced into the system.

EDIT to add:

here, I agree... it forces the liquidity out into the open.. and if they start charging for deposits held at the BofE...? capital flight??

I guess what I am saying is there is no point charging for the reserves held -- BOE only need to pay less than the alternative. I suppose if the negative spread didn't cause banks to withdraw reserves they could start charging, but that is jsut a more extreme version of the same isn't it?

[Thatcherschild]

Does Rothschild's bank do mortgages? I suppose they must...

They are flush with cash, as they are a merchant, rather than a High Street, bank. So they can lend to clients who they consider to be the best (in their eyes) risk. I haven't checked the terms, but I imagine that loans are made to, principally, white collar workers by specifying a minimum loan amount (at a high level) with a high deposit requirement.

Then sit back for two years and wait for the fixes to end, and you have effectively pinched all the high wage-earners from the High Street - just at the very time that interest rates are going through the roof and doctors, accountants, lawyers and, dare I say it, bankers are stuck with really nasty SVRs that they can't escape.

I won't say "simples".

Doh!

[FreeTrader]

With the BoE continuing to buy gilts in the secondary market faster than the DMO is issuing new supply, gilt yields are effectively being capped. Until the QE programme ends therefore, the place to look out for signs of investor concern over the UK's fiscal position is in the currency markets, not the government debt market.

Today the DMO released its 2008-09 Annual Review (3.5mb PDF), and it's perhaps no coincidence that this was published on a sleepy Friday before a Bank Holiday. The outlook for the UK government finances is truly dire, and it's really not surprising that the BoE is now monetising as much of this debt as it can while it's still able to argue that the big bad deflation wolf is knocking on the door.

As for unwinding QE, I seriously doubt that the BoE will ever sell anything but a token amount of its gilt holdings back into the market.

Here's the DMO's table of illustrative financing projections for the next four fiscal years:

Note that we have the basic Central Government Net Cash Requirement (CGNCR) as projected in the 2009 Budget, but additionally we have to add gilts which will be redeemed over time. This is a problem the DMO will constantly face for the foreseeable future because it will have to roll large quantities of maturing debt.

The figures suggest that the Government will have to find nearly £700bn in cash over the four fiscal years in question. The DMO is at pains to point out that not all of this will necessarily be financed by sales of gilts (National Savings and Treasury Bills will almost certainly play a part) but there's little doubt that gilts will account for the majority of the financing.

But wait a moment...

The funding estimates above are based on the projected redemption profile for gilts at end-March 2009. Later in the report there's a chart that shows this profile:

Remember though that new gilts are being issued this year that will add to redemptions in the coming years. Here's the estimated redemption profile at end-March 2010:

As you can see, the first four years are almost identical, but look at 2013/14. In the first chart it shows redemptions of just £21bn, and this is the figure that has been used in the financing projection I showed above.

Now look at 2013/14 in the second chart. It's over £60bn. So in reality the Government is going to have to find an additional £40bn in 2013/14 to cover these extra redemptions. That's fine if holders of gilts reinvest redemption proceeds into new issues, but there's no guarantee that they will do so, or they may well demand a much higher yield on their investment.

I don't know for how long this position is sustainable, but I just can't see the DMO being able to sell gilts on this scale unless the BoE continues to indirectly monetise some of the issuance as it is doing now. I know we can get blasé about these numbers sometimes, but the sums involved are simply staggering. Add together the annual tax take on VAT, Corporation Tax, Capital Gains Tax, fuel duties, tobacco duties, alcohol duties, betting duties, Stamp Duty, and Inheritance Tax...and you're still short of the amount of gilts the DMO will be trying to hawk to investors in each of the next four years.

UK plc is in a very serious mess, and only one thing is hiding just how bad things really are: Quantitative Easing. When (if?) the programme ends, be prepared for some fireworks in the gilts market.

[lowrentyieldmakessense(honest!)]

UK plc is in a very serious mess, and only one thing is hiding just how bad things really are: Quantitative Easing. When (if?) the programme ends, be prepared for some fireworks in the gilts market.

they will carry on with it

as you say maybe the currency market is the one to watch - not gilt yields

[yellerkat]

UK plc is in a very serious mess, and only one thing is hiding just how bad things really are: Quantitative Easing. When (if?) the programme ends, be prepared for some fireworks in the gilts market.

Another great post and more thanks, salaams etc.

It's your last line that really, really worries me.