A rise in bond yields caused by a fear that short term rates might go higher could stop the MPC raising rates further – yet another example of the Law of Self Contradicting Expectations.
In an eerie repetition of the bond squeeze a year ago that, combined with Bank of England incompetence and a bad market reaction to her programme of tax cuts, brought Liz Truss’s government to a premature end, the yield on the UK government 30 year bond has risen 21 basis points in the week to Wednesday 4 October to reach 5.00%, its highest level this century. A similar rise of around 20 points has taken place for most bonds at the longer end of the spectrum. The yield on the 10 year gilt has risen to 4.62%, the highest since October 2008.
Why has this happened, are we likely to see yet another new prime minister and what does it mean?
The easy one first – a new prime minister is unlikely, at least until the next election. Rishi Sunak is not being blamed directly for the rise in yields which is international (though the rise a year ago also was partly so).
The gilts market is a gossipy place and it’s always easy to get a story about why yields are moving. In this case it seems to be the sudden realisation that gilt issuance is likely to stay high for a long time while the reluctance of inflation to fall more rapidly means that short rates are now expected to stay higher for longer. The move has taken place in most countries, led by the US.
The yield curves are currently inverted (long yields lower than short yields) though less so than a week ago and this is normally only a temporary phenomenon.
It may come as a surprise to those who have access to forecasts produced by my Cebr colleagues that the gilts market had not realised the likely persistence of inflation, borrowing and high short term interest rates earlier but the quality of City analysts is probably not as good as in their heyday (their status and salaries are much reduced since then too).
Our take on what it means is not as excitable as some others’. We think the current pattern of yields is more sustainable than last weeks’. We accept that some asset markets, especially property, are likely to be further hit around the world and for many retail and office buildings the writedown in asset values makes them worth no more or even less than the borrowings raised against them. Someone will have to crystallise these losses, but the economic system is surprisingly good at this. In some places (like China) the problems will combine with other problems and hold growth back but this is not new news and is factored into our forecasts.
But probably the most likely impact of the rise in bond yields is to kill off the likelihood of a further MPC rate rise, since the impact of higher yields on property and other markets should be enough to prevent the need for further tightening. In this sense, a rise in yields, caused by a fear of higher than expected short term rates, will itself prevent the rise in short term rates that had been feared.
This looks like yet another example of my Law of Self Contradicting Expectations – that once markets start to believe certain things will happen, prices adjust so that they don’t need to happen any more. It’s one of the paradoxes of markets.
Douglas McWilliams is Deputy Chairman of Cebr, the economics consultancy and Co Chairman of the Growth Commission
