Idiots

Ministers could save billions of pounds and boost savers’ pensions by a switch to how the Government pays for the pandemic rescue package, according to research.

Consultant LCP claimed that the UK was “missing a trick” on how it financed borrowing plans by relying heavily on fixed-rate gilts, rather than opting for inflation-linked debt.

Next year, around 90pc of the expected £300bn of gilts will be fixed-rate, meaning investors are guaranteed a set return. For the remaining 10pc, payouts will vary depending on inflation – which is so low at present that the amount due is far less.

Which way do we think inflation is going to go? Not down, right? So the rational borrower would be cramming on the fixed rate debt and retiring as much as possible of the inflation linked….

10 thoughts on “Idiots”

  1. Also how can the government “ save billions of pounds and boost savers’ pensions” by doing this? Since the interest payments are from the government to the pension funds, surely it’s one or the other?

  2. The LCP argument as summarised here does seem idiotic, but the best strategy for the government isn’t obvious.

    The breakeven inflation rate (the average future inflation rate at which returns on conventional and I/L gilts will be the same) for 30 years is 3.2% per year. So investors are already anticipating that inflation will run distinctly above the official target.

    The government taking the same side of the bet, by issuing only conventional debt, is not going to reassure investors and might not even be profitable.

  3. The government taking the same side of the bet

    V good point. Even if it’s kidology as much as economics, more inflation-linked borrowing might be worth a go.

  4. The argument above ignores one key point – insurers are virtually forced to buy index-linked gilts thanks regulations introduced under New Labour. So the real yield on IL is lower than on conventional gilts and will remain so until enough extra IL have been issued to cover all those liabilities that are required to be matched in the future.
    LCP are not idiots – they just know more about insurance and pension fund regulations than Tim.

  5. Can’t see what LCP actually said, but I wonder if there’s mechanism where it makes sense.

    Fixed rate debt is badly affected by inflation, floating rate less so, equities much less again.

    De-equitisation has been going on for how long now? So dividend paying equities are in short(er) supply than when inflation was last high(er) (depends on your timeframe – 70s, 80s, 90s?). The alternative is pure growth through non-dividend paying assets (including alternatives, like umm, BitCoin).

    Typical holders of sovereign debt have been domestic pension funds – predictable cash flows for an ageing population. But the demographics there just took a hit, possibly for the next few years. 10? Longer?

    UK wage distribution has changed significantly twenty years after the introduction of the minimum wage. The ONS says something like 10% of jobs are now clustered within 2~3% of MW.

    Consumers seem to have shifted from owning goods to leasing them – probably related to the wage clustering, but also low inflation expectations, given Amazon/China.

    Corporate earnings (for consumer goods) have possibly become less volatile(?) over the short-term as the subscription model for ownership took hold, so larger cash balances became more common. Those cash balances ended up in domestic sovereign debt, probably at the short end.

    Higher demand from corporates competed with pension funds to hold yields down, making it easier for sovereigns to issue more short to mid term debt, thus easier for governments to spend (this means that arguments about the CT rate are just bollocks – sovereigns have been able to spend the direct revenue from CT plus the debt amount held by larger corporates – in total probably much, much higher than the CT rate would normally allow).

    So, inflation hits, somewhere.

    Sovereigns face higher coupon rates to offset the expected inflation rate over the entire term of new issuance. Current holders are looking at mark-downs on balance sheets as yields rise. Corporates have the same problem – spreads might widen, and the equity risk premium suddenly doesn’t look so bad. Dividend payments increase.

    Governments suddenly have more competition for investor funds. In which case, it might make sense to shift the index-linked portion of new issuance up a bit, to offset the potential drop in cash flowing in, at the same time as future government expenditure on the oldies is expected to drop as a proportion of total spending.

    Net-net, it might be OK as investors bid over par for the indexation.

    All a bit tricky, really.

  6. I read somewhere that gilts are already 25% index-linked by value, which is unusually high. Does anyone know whether that is (i) true, and (ii) important?

  7. I looked at Gilt issuance so far this calendar year and it is overwhelmingly fixed rate – roughly 48bn out of 52bn.

  8. Ah, the famous english trap of “could, would, should”.

    Those can do a lot of non-committal leg-work…..

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