Since March 9th, there have now been two instances where UK government gilt yields have been negative for the first time in their history (March 9th and 20th May, correct at 2nd June).
This begs the question as to why would anyone want to buy government bonds and get back less than they bought them with at the end of the term?
First of all, it’s important to note that this has been in practice in several other nations for a while, notably Japan and Germany where governments have discouraged private investors away from gilts. Government debt is traditionally perceived as lower risk than the stock market, for example, which can be much more volatile.
At face value you would think that investors have taken a grim view of the future and decided they would rather get most of their money back in a few years than potentially even less.
It’s a bit more nuanced than that though. Pension funds, banks and insurance companies are required to hold liquid stocks in their portfolios representing low and high risk so they will often buy government debt as a low risk option, so that hasn’t changed in some of these scenarios.
It can also be designed as a hedge, whereby buyers of the debt believe the value of the debt will rise in the future and they will be able to sell the debt on for a profit.
What does it say about the state of the economy?
Generally speaking, this is a negative indicator for the economy. If buyers of this debt thought there were better alternatives in the market and the UK’s growth prospects were healthier, they wouldn’t be buying it, or at least not as much of it. It could be a pre-cursor to the Bank of England base rate going negative in the near future.
It also means pension fund returns may be lower as there will be negative growth in parts of portfolios that contain UK government bonds.
On the other hand, the government will be able to finance some of the borrowing it has been forced into by Covid-19 at a much lower price than previously and that could lighten the burden on the taxpayer to repay the money in time. When that figure is in the hundreds of billions, every hundredth of a percentage point really does matter.
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This information is based on the opinion of Wren Sterling and does not make a recommendation to suitable investment strategy. Investors should seek independent financial advice regarding their own investment strategy.