There’s an old and well-known adage in business that the customer is always right; truth be told not everyone in business actually believes this all the time, but there are occasions when it becomes more true than usual.
The Government’s customer when it comes to financing is the capital markets. We’re currently witnessing a rather significant rerating of the customer’s expectations with regard to the price of the product on offer. So, the question we ask at the moment is whether the customer is right at this moment, and if the customer is right and that gilt prices should be low, with correspondingly high gilt yields, what can other interested parties do to change the price expectation of the customer.
A gilt is a rather old-fashioned product in the respect that it comes with a lifetime product guarantee from the seller. In large part it is therefore the belief that this guarantee will be valid that ensures faith and trust is maintained in the product. If trust is high then the price can also be high, with correspondingly low yields. A leap in yields such as we have observed in markets over the last few business days is an illustration to some extent in a breakdown in this relationship (allied with fears over persistent inflation).
How can faith be re-established? Demonstrations of fiscal probity from the government? But that may look like a U-Turn and political weakness. Positive independent assessments from the Office for Budget Responsibility? They’re not due for 2 months! Finally, and closer in time to the present, is the ability of the Bank of England to demonstrate its independence and garner credibility through at least meeting the customers demands on the path of base rate, showing the monetary resolve the customer feels necessary to counter the threats of inflation and fiscal expansion.
We feel there will be a little give and take in the relationship between the Bank and the customer if action is meaningful and swift, to that end we have revised the terminal rate of our interest rate forecast to 5%, with 200bps of tightening before Christmas…should this be delivered we hope to see a gentle and gradual reversal of gilt yields, the truest demonstration of the customers happiness.