U.K. Bond Auction Fails

This week, the United Kingdom government bond auction failed for the first time in seven years. What is behind investors’ reluctance to buy bonds and what impact may it have on the Bank of England monetary policy?

At Trading Economics, we think that rising U.K. debt levels and renewed fears over inflation made investors unwilling to participate in the auction. In fact, the U.K. fiscal position is alarming. With revenues collapsing and the government still committed to generous spending plans, the fiscal deficit rose to £75.2bn in April-February versus £23.0bn a year earlier and is likely to reach about 6.3% of GDP for the whole 2008/09 fiscal year. Moreover, the recent IMF forecast shows that deficit may reach 11.0% of GDP this fiscal year. To make things even worst, inflation had exceeded everyone’s expectations, rising from 3 per cent in January to 3.2 per in February.

Looking further, the failed bond auction is a bad sign for the quantitative easing policy, initiated by the Bank of England at the beginning of March. Indeed, one of the channels of quantitative easing is the effect on the cost of borrowing. When the Bank purchases bonds, it reduces the supply of those instruments in the economy. That action should boost the demand for new bonds and, at the same time, make it cheaper for businesses to borrow. But if there is no demand for bonds, their price is rising and long term interest rates are increasing as well. That could then force the Bank of England to expand QE beyond prudent levels.

Anna Fedec, contact@tradingeconomics.com
3/25/2009 3:57:42 PM