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.
• Credit rating agencies weigh in on independent Scotland – Alex Hern, February 6th 2012
• No, Gideon, low gilt yields aren’t good news, and here’s why – Cormac Hollingsworth, November 16th 2011
• The current crisis: brought to you politician by inaction and unaccountable credit rating agencies – George 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 continues – Will Straw, June 23rd 2011