As political risk recedes, UK public debt is back in fashion
FFOREIGN EXCHANGE commerce is, for the most part, a youngster’s game. Find a veteran whose memory stretches beyond a few decades, and he’ll tell you that there are really only two numbers that matter to the pound. These are 1.40 and 2.00, the limits of its normal trading range against the US dollar. Since 1985, every time he has touched one or the other, a turning point is due (see graph).
That was until June 2016, when Britain’s vote to leave the European Union caused the pound to collapse. The fallout has kept him there ever since. Political headlines have become a constant predictor of fluctuations in the pound’s exchange rates, prompting comparisons to emerging markets. Foreign investors looked at UK assets with disgust, fearing that they would be valued in a currency that could dip further if the most disruptive version of Brexit comes through. Those who wanted to hedge against this risk found it increasingly costly to do so as speculators were betting on the pound taking another beating.
In this case, the mauling did not take place. Although the trade agreement signed between Great Britain and the EU excluding funding for fisheries, the transition period ended in a more orderly fashion than many had feared. As the deal loomed, bets against the British pound began to unwind, making it cheaper for overseas buyers to hedge currency risk on sterling assets. Foreign investors have flocked to gilts (UK government bonds) like never before, buying a record £ 89.8 billion ($ 127.4 billion) in the year through April 2021. The pound even spent the last month trading above $ 1.40.
Foreign enthusiasm for gilts is not just due to a resurgent pound. Rapid vaccine deployment indicates a faster resumption of the covid-19 pandemic in Britain than elsewhere in Europe. This, combined with the fact that the Bank of England is generally seen as more hawkish than the European Central Bank, means that the interest rate on UK government debt is comparatively attractive. “It becomes easier to sell gilts with a return of 0.81% when people look at France’s 0.17%,” says Kit Juckes of Société Générale, a bank.
The political risk remains, especially in the form of a looming struggle over the future of Scotland. But the fiscal impact of a Scottish exit on the rest of Britain would be moderate and on the rise. In the 2019-2020 fiscal year, Scotland accounted for 9.2% of Britain’s total government spending and around 8% of its tax revenue. And some of that income would likely be kept, as the financial firms currently headquartered in Edinburgh have decamped to London. “Hive Scotland off, and the rest of the UK from a budget deficit of around 2% to GDP at one of about 1.5%, ”says Thomas Pugh of Capital Economics, a consulting firm.
It will not be easy in the months to come. A row between Westminster and Brussels over the implementation of trade rules in Northern Ireland threatens to reopen the arguments that led to the Brexit Withdrawal Agreement. It would hurt Britain’s business prospects. Meanwhile, the Treasury is considering giving the government a veto on stock quotes for reasons of national security could reduce the attractiveness of the country’s financial markets for foreign companies. But for now, the money looks set to keep pouring in. UK, says Mr. Juckes. “There must be an opportunity there. ” ■
This article appeared in the Great Britain section of the print edition under the headline “Gilt-y Pleasure”