Gilt yields have turned negative for the first time following Bank of England governor Mark Carney’s speech yesterday pledging to do everything it takes to keep the economy on track.
Gilts maturing in March 2018 are now yielding -0.04 per cent. While it is only one gilt to turn negative so far, the development is a landmark for the UK interest rate environment, meaning anyone who buys this gilt is paying the UK government for the privilege of lending it money, even though ratings agencies have downgraded UK government debt.
The UK now joins Germany, Austria, the Netherlands, Denmark, Switzerland and Japan, where gilt yields have turned negative.
As a result of the Governor’s speech yesterday, markets are now expecting an interest rate cut, and/or more quantitaive easing over the summer, which has pushed fixed interest rates down.The benchmark UK 10 year gilt is now yielding 0.87 per cent, down from 1.37 per cent before the referendum vote, and 4.5 per cent before the financial crisis.
Meanwhile the stock market has risen sharply after Carney’s speech,in part because a 3.5 per cent dividend yield from the stock market now appears more attractive than interest rates on cash and bonds, which look like staying lower for longer, says Hargreaves Lansdown.
Hargreaves says such low and negative gilt yields suggest a long period of weak economic performance and loose monetary policy to come. Markets are now pricing in a cut in base rate from 0.5 per cent when the Bank of England’s monetary policy committee meet on 14th July, the firm says. They are also pricing in a one in four chance of base rate turning negative over the course of the next year.
Hargreaves Lansdown senior analyst Laith Khalaf says: “The UK is now officially through the looking glass, as the Brexit vote has pushed gilt yields below zero for the first time. Remarkably markets are now expecting interest rates to lurch downwards, despite already being at record lows.
“The ultra-low interest rate environment paints a depressing picture of our economic prospects, though the gilt market has been so heavily tainted by central bank interference, it’s hard to know how reliable an indicator it is.
“Such low interest rates are great for borrowers, but awful for cash savers, and for banks. Cash savers have already suffered 7 years of ultra-low interest rates, and on current expectations it looks like they will comfortably see out a decade without getting a half-decent return on their deposits.
“The stock market likes falling interest rates though, and indeed the accompanying fall in the pound, so understandably the Footsie rose on the back of Mark Carney’s comments. In a world where you have to pay money to lend to the government, an investment in the stock market which pays you three to four per cent a year looks attractive, even if it can be volatile.
“In his speech yesterday, Mark Carney did issue a warning that there is a limit to what central banks can do, and that the fate of the UK economy also depends on the actions of others. It is unclear whether he was referring to the forthcoming EU negotiations, or whether he is hinting to the Treasury that fiscal policy needs to join in the battle to stimulate the economy.
“Either way, with interest rates approaching zero, the Bank of England is testing the limits of its powers.”