The Bank of England has downgraded its growth forecast for 2011. It now expects the economy to expand by about 2% rather than 2.5%. This followed the news that factory output has dropped in June, while a widening trade deficit pointed to weaker external demand. Ten-year gilt yields have fallen to a record low under 2.6% as their price has risen, lowering our cost of borrowing. This week it cost less to insure British debt against default than German paper, according to prices in the credit default swap (CDS) market.
What the commentators said
The slide in CDS costs and gilt yields appears to show that investors consider Britain “one of the safest of safe havens right now”, said Andrew Peaple in The Wall Street Journal. It seems that not even the riots can dispel that perception. But this is “a strange sort of safe haven”. It’s a case of the UK being the best of a bad lot.
“In a world of dysfunctional politics, investors see the UK as a beacon of stability” and reckon the government is unlikely to deviate from its deficit reduction plan. America and Europe haven’t convinced anyone that their debts are under control. What’s more, Germany is likely to have to spend more money in order to keep the eurozone together, as Jeremy Warner pointed out on Telegraph.co.uk. Germany is becoming less creditworthy, which explains the change in CDS prices.
But investors counting on the UK’s deficit-reduction programme should beware. They are not only assuming that the coalition can stay the course, but also that “growth will be consistent with the Treasury’s deficit-cutting ambitions”, as Ian King pointed out in The Times. Yet after the lacklustre first half, the Office of Budget Responsibility’s 1.7% estimate for this year is looking optimistic.
Indeed, that’s the main reason why gilt yields have fallen, said Stephanie Flanders on bbc.co.uk – declining growth prospects. Yields have slumped across the world as the outlook has darkened. America’s are back to 2008 crisis levels and ours have not been at these levels since just after the war. “When it comes to the global recovery, we are not a safe haven and we never will be.”