Hamish McRae: Be grateful for the markets' logic, don't question it

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The Independent Online

The world is unfair and the sovereign bond markets are most certainly so. Take the rate for 10-year debt on the markets yesterday. Here in the UK our government could borrow at just under 2.2 per cent. France, which has a smaller deficit, though slightly higher debt levels, would have to pay more than 3.5 per cent. Germany, with an even smaller deficit but debts still larger than the UK, can borrow at 1.9 per cent. And the US, which has the highest deficit of any major country in the world and, as we have seen this week, an utter inability to agree on how to cut it, can borrow at 1.95 per cent. All these countries have the same top credit rating, AAA, yet the rates they are charged are quite different. Rum, isn't it?

The fact that the UK not only has kept its top rating but can borrow from the markets so cheaply will be used by the Coalition as a key justification for sticking as far as possible to its deficit-cutting plan, despite lower-than-expected growth. As of yesterday, we were still on track for this financial year's target deficit of £122bn, but the Office for Budgetary Responsibility may forecast some deterioration when its report is published next Tuesday.

A sensible rule of thumb would be to expect the return to structural balance to be pushed back a year to 2015-16, or even 2016-17. Plan B is still arguably Plan A, but Plan A done somewhat more slowly. Would the UK under those circumstances still retain its ability to borrow at these very low rates? The key to this lies in the psychology of the bond markets.

Germany is trusted because for more than 60 years it has followed a path of fiscal orthodoxy. It even managed to carry the burden of absorbing East Germany while keeping borrowings more or less under control. If the eurozone survives, Germany remains its anchor. The US is trusted despite everything because of the size of the economy, the country's relatively favourable demographic profile and its ability to print the dollars if need be.

France is less trusted than Germany for reasons that are not clear. I think these come down to doubts about how its debts might fare were the eurozone to break up. France's record since the Second World War was of periodic franc devaluations. The explanation, atavistic though it seems, is that the world's savers think there is a bit too much of the Latin and not enough of the Teutonic in the French make-up.

But then, on the past record, the UK has not been a paragon of fiscal or monetary virtue either. We have the highest rate of inflation among the developed countries and the second-largest deficit. We have devalued several times since 1945 and had to call in the IMF in 1976. We are helped by having our own currency, for we can print the stuff it we have to. Yet it is to the huge credit of the Coalition that it has hung on to this status. Fingers crossed we can keep it.