DEMAND FOR UK GILTS FALTERS AS PUBLIC SPENDING SOARS

DEMAND FOR UK GILTS FALTERS AS PUBLIC SPENDING SOARS

As the Bank of England failed to receive enough bids to cover the whole of a 1.75billion Pound auction for long-dated gilts yesterday, there was one question which sprang to mind in light of the government’s recent fresh plan to raise more cash for a heavily indebted UK this year – guilty of debt mismanagement? Clearly, Gordon Brown’s announcement yesterday to try and raise around 150 billion Pounds of finance for the UK economy over the year from global markets, combined with the fact that the BOE couldn’t find enough demand to sell a small portion of this debt, are linked. The market simply believes that UK finances could be becoming way too leveraged in the face of tumbling growth and rising regional unemployment.

An economy which has relied explicitly on financial services over the last couple of years to finance spiralling public spending and public debt, quite frankly, is not going to look like the best buy as this area of the world economy contracts severely, especially with yields being sought by investors for sovereign debt increasing in the face of overwhelming supply. This, unfortunately, represents yet another piece of market information that does not bode well for the Pound. If it becomes increasingly apparent over coming months that the UK public sector is savagely wasting more money amidst a continued slump in growth and stagnancy in the financial sector, then de facto, the UK currency will continue to be unattractive. Not only will the obvious happen, in terms of global investors shunning UK gilts for fear of default, but traders will continue to conduct raids on the currency in attempts to capitalise on general sentiment in burrowing it further into the floor.

There really is a terrible risk at the moment of a ‘perfect storm’ for the UK. Prices continue to rise as the Sterling sell-off, sparked initially by the financial crisis, puts pressure on importers to recover exchange-rate losses. This combines with deflationary pressure to create a scenario where monetary policy, instead of being effective, merely exacerbates inflation whilst doing little to calm the real effects of negative growth. Investors, who, having already removed vast capital from the UK thanks to the retreat of global finance and equity instruments, also begin to remove fixed-income funds as fear grows that Sterling will be physically devalued by quantitative easing with the UK possibly defaulting on debt. Could all these factors combine for another 1976-esque IMF bailout later this year or next? As Mervyn King noted in Parliament yesterday, only exceptionally stringent management of both figures and public perception by the Government can now avert such a crisis.

Today sees UK Retail Sales in the morning with US Unemployment Claims certainly providing some interest for the afternoon. Combined, both sets of figures ought to keep the pressure on GBP/USD, currently trading around the 1.46 mark, whilst also capping GBP/EUR gains, trading this morning around 1.07.

Raphaels Bank CFX Team
0800 587 8722
cfx@raphael.co.uk
www.raphaelsbank.com/cfx


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