MUNIX COMMENTARY – WEEK OF 26 April
A billion here and a billion there and it soon all adds up!
Eyes often glaze over when enormous figures are talked about. The news that the UK government borrowed £303 billion in the fiscal year 2020-21 is difficult to comprehend. To put that into perspective, such borrowing was broadly equal to 15% of the value of everything produced in the country over that period, whilst it was only equal to 2.6% of GDP in the previous fiscal year 2019-20. Put another way, it is akin to every adult in the country adding another £7,000 to their mortgage and credit card, when their personal debt was already £32,000.
How we got here is easy to understand. In a normal year, the government spends about £750 billion on goods, services and transfer payments such as pensions. Last year it added a further £200 billion, including for example £80 billion on subsidising people to stay at home on furlough and similar job retention programmes. Total debt has now reached about £2.1 trillion, or in other words broadly equal to the entire output of the UK economy during a year.
The UK, and indeed most other countries, have coped well with this surge in debt issuance. Truth be told, the demand for and supply of debt are rarely the most important factors driving the price of government bonds. A whole variety of other factors such as long-term real interest rates, inflation expectations and credit ratings would need to be included in any model. However, one important factor helping the economy cope with such a surge in debt issuance has undoubtedly been the reactions of the Bank of England, and other central banks too. QE programmes have stepped up, in some cases very significantly. Last year, the ECB purchased more debt than the EU governments issued. Interest rates close to zero meant that the cost of servicing the UK’s debt last year was only about 2% of GDP, amongst the lowest ever.
It is for this reason that the announcement by one of the smaller central banks becomes more significant. Last week, the Bank of Canada announced that it would soon start tapering, that is to say reducing, the size of its debt purchase programme, and indeed hinted that it could consider raising interest rates – albeit within 18 months. Forward guidance is quite long term in nature for many central bankers at present, as they strive to reassure the public.
Tapering announcements have been rather important in the past, of course. The statements made by the Federal Reserve in 2013-14 and 2017-18 were associated with a degree of market stress and price volatility – in simple terms too many people rushed for the exit at the same time. A recent survey by Bloomberg indicated that most economists think the Fed will start tapering again within a year – although Jerome Powell, Fed Chair, has been very careful to be cautious in his latest statements.
Where does the Bank of England stand in this regard? It has been remarkably quiet recently, compared with the stream of statements from the ECB or Fed – admittedly few of which have said more than ‘nothing to watch here, move along please’ in terms of growth, inflation, and their policy response. In one sense the Bank’s attitude is quite understandable – the bond market is well behaved, financial stress is low, inflation expectations are well anchored. Nevertheless, the economic backdrop is moving rather faster than usual. Business surveys in March and April definitely show a sharp improvement in household and business sentiment as the lockdown ends. Economists are busy upgrading their forecasts for how strongly the UK economy could grow this year, with estimates of 5-6% moving towards 7 or even 8%. In May, or August, or November, the MPC itself may start to give hints that its asset purchase programme need not continue at the same rate. As normal market supply and demand factors begin to appear, so should the true price of debt.
Andrew Milligan is an independent economist and investment consultant. This note should be considered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent Economist and Investment Consultant
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making