Blog
Gilt trip - how the government raises cash
26th March 2009
This brief “Industry Speak Explainer” from the Guardian provides a vsimple explanation of how the government borrows money by selling gilts. It explains how the Bank of England’s policy of quantitative easing, which involves buying up to £75bn of gilts in an attempt to drive up their price and push down the yield, is an attempt to avoid crowding out by persuading investors to sell gilts back to the Bank and spend the cash on other assets instead, helping to drive up their prices, reduce the cost of borrowing, and stoke new demand across the economy.
The failure to sell-out of gilts at bond auction yesterday is widely covered in the media. These were 40-year bonds, which is towards the longest-term debt that the government issues, and so were not covered by quantitative easing programme under which the Bank will buy bonds maturing between five and 25 years,.
This means that longer-dated gilts do not have a guaranteed buyer in the central bank.
As well as concerns about the sheer volume of government borrowing at present,the problem is likely to be that the return on offer was not sufficiently attractive, particularly following the news of the rise of CPI inflation to 3.2% - inflation erodes the value of bonds, which pay a fixed rate of interest over time.
Following the failure of the auction gilt prices fell on the markets which effectively raised their yield – the 40-year gilt yield rose 8 basis points to 4.54 per cent. Meanwhile John Lewis was announcing a shorter term bond issue due to mature in 2012, and paying an 8% yield. When highly rated businesses such as John Lewis are issuing bonds offering an 8% return, it is little wonder that some investors in the bond market decide to shun new issues of very long-dated government debt.
More reading on yesterday’s bond auction: