Osborne’s austerity is failing at the one thing it’s supposed to do


 

A bad morning for the chancellor today. Credit ratings agency Moody’s has put Britain on a negative outlook, indicating that it has doubts over the nations ability to retain its triple-A rating.

The entire rationale of austerity is based around the primacy of market confidence. Without confident markets, the argument goes, Britain cannot retain low enough interest rates to maintain its debt at a reasonable level. Believing this, the chancellor has been bullish about the extent to which low bond yields (the primary way governments borrow) prove his plan is supported.

Cormac Hollingsworth demonstrated the weakness of this argument on Left Foot Forward, back in November:

The City has not fallen madly in love with the government’s policies. Actually, the explanation for the lowest gilt yields in 50 years is that the outlook for growth is so bleak that everyone is seeking refuge in government bonds, traditionally the safest form of debt.

To illustrate this, I’ve graphed the level of gilt yields versus the HM Treasury’s summary of the City’s forecast for 2012 growth. The forecast has been collected since February this year, and I graph the forecast for February, April, July, and October together with the gilt yields for the end of that month.

As growth expectations for 2012 have fallen (vertical axis), 10 year gilt yields have also fallen (horizontal axis). This is consistent with the panic view. But what’s happening to the City’s predictions for borrowing?


The HM Treasury surveys ask for a prediction for government borrowing for both 2011/12 and 2012/13, so we can graph financiers’ expectations of the total borrowing for those two years versus gilt yields. And unfortunately, the conventional newsroom wisdom is wrong. Over the course of this year, ever-lower gilt yields have been associated with ever higher expected borrowing for the next two years.

Low gilt yields don’t decisively demonstrate market confidence; they can often be because of market fear. This ratings wobble suggests that the UK is suffering from the latter.

Despite macroeconomic policy aimed first and foremost at pleasing the markets – in essence, building the treasury into a body designed to react to the pronouncements of the credit ratings agencies – Britain now holds a negative outlook.

Whether or not the nation is actually downgraded is largely outside of the chancellor’s hands.

The agency’s report says:

This could happen in one of three scenarios, all of which would imply lower economic and/or government financial strength:

(1) a combination of significantly slower economic growth over a multi-year time horizon — perhaps due to persistent private-sector deleveraging and very weak growth in Europe — and reduced political commitment to fiscal consolidation, including discretionary fiscal loosening or a failure to respond to a deteriorating fiscal outlook;

(2) a sharp rise in debt-refinancing costs, possibly associated with an inflation shock or a deterioration in market confidence over a sustained period; or

(3) renewed problems in the banking sector that force a resumption of official support programmes and spill over into the real economy, indirectly causing lower growth and larger budget deficits.

What this report shows is the problem with staking a government’s economic reputation on the capricious, ideological and often plain wrong pronouncements of an unaccountable corporation, as Osborne did in November 2010:

“Our first benchmark for Britain is to cut deficit more quickly to safeguard Britain’s credit rating.”

and May 2011:

“Our credit rating had been pt on negative watch. Now… thanks to the policies of this coalition government… Britain has economic stability again.”

Instead of focusing on market confidence, and aiming directly at what is ultimately an effect rather than a cause of a strong economy, the chancellor should go for growth, encourage genuine strength, and from that confidence will follow.

See also:

Credit rating agencies weigh in on independent ScotlandAlex Hern, February 6th 2012

No, Gideon, low gilt yields aren’t good news, and here’s whyCormac Hollingsworth, November 16th 2011

The current crisis: brought to you politician by inaction and unaccountable credit rating agenciesGeorge Irvin, August 8th 2011

Can Europe’s leaders end the eurozone nightmare?George Irvin, July 21st 2011

IFS boss: Plan B “likely” if growth downgrade continuesWill Straw, June 23rd 2011

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  • Awake!

    ‘The entire rationale of austerity is based around the primacy of market confidence. ‘
    Today’s 10 year sovereign bond rates, rigjht now
    UK- 2.088 %
    France- 2.944 %
    Germany- 1.908 %
    Italy- 5.534 %
    Spain- 5.238 %
    Greece- 29.925 %
    It goes on. Basically Uk gilts (bonds) are still ranked amongst the very top globally by the market. That’s now. Obviously Europe cabn change things, but that’s what the market says now. Not what the author of the piece writes, just b
    Ooops, nearly forgot, people bought UK bonds after that announcement, the yield dropping 4 b basis points today…

    ‘Actually, the explanation for the lowest gilt yields in 50 years is that the outlook for growth is so bleak that everyone is seeking refuge in government bonds, traditionally the safest form of debt.’
    Really?? then go buy some greek debt then at 29%, fill your pension fund with it, go on….

    ‘Low gilt yields don’t decisively demonstrate market confidence; they can often be because of market fear’. And when there is fear you buy the stuff you feel confident with- it’s called a flight to quality.
    Also, a bone to pick-this site and NS late last year. You both refused to accept tha UK was a safe haven, that each time euro troubles kicked off, UK gilts moved higher AT THE SAME TIME. You chaps chose Krugman’s bullshit that the UK yield drop was in response to GDP slow downs, when each time bad news hit the wires, one could actually SEE UK bonds being bought and the eurocrap being sold, but in a sick twisted universe u chose to go with the explanation that put down UK. Politically motivated maybe- ARGUE IT WITH ME!! Please do so. Or maybe the post gets deleted, who knows.
    Charts?? Go and look at the price action AS THE NEWS HIT, not day end data points.

    ‘Despite macroeconomic policy aimed first and foremost at pleasing the markets’
    And that’s the nail in the coffin really, the writer confuses a rating agency with the market.

    ‘the chancellor should go for growth, encourage genuine strength, and from that confidence will follow’
    The primary risk facing UK is interest rates, because of the massive debt thatb MOODY’S make referance to. No point in finger waving, but the debt means it’s difficult to push on a piece of string, AND, more crucially, increase in interest rates hikes means throwing money away. Think about this- france, similar economy, population, geography, aspirations etc… France pays 50% more now on it’s 10 year borrowing. Hands up those with debts who want to see interest payments go up 50%? no?? How about 150%
    mmmmm. Election lost
    Stop barking up the wrong tree. You won’t always get this help.

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  • http://twitter.com/Newsbot9 Newsbot9

    Oh yes, keep defending this crashing, broken economy. There is no way but down for it, and government costs will soar in the coming years because of the dismantling of cost-saving measures and deliberately-caused social breakdown.

  • Awake!

    newsbot
    try not to panick , keep calm and objective.
    We’re paying less than almostr evryone in europe in interest. That money gets used to help people. Do you understand that?

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  • Anthony

    I thought America got downgraded and their interest rates actually fell? This interest rate scare story falls very short and is never supported by the facts. the UK is nothing like Greece or Italy. Through interest rates you’re confusing the markets with ratings agencies.

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