Expert View: Falling British bond yields: a tale of the unexpected

Given the inflationary pressures, the decline is truly remarkable

Consider the following facts: the UK government will borrow £37.2bn this year; an upward trend in public sector pay was underlined last week as university lecturers threatened not to mark exams to back up a pay claim; the US consumer and the US government continue to borrow hugely; and oil prices are at record levels.

This should all be very bad news for bond markets, and US bond yields have indeed been rising recently (which means falling prices). But on a two-year view, it is more notable that UK bond yields have fallen markedly since 2004. The average yield on 10-year corporate bonds this year is 4.8 per cent, against 5.8 per cent two years ago. This comes late in the economic cycle - two years after the US Federal Reserve started tightening policy.

The American economy has enjoyed sustained growth since 2002. This year, the long-delayed recovery of the Japanese economy and continuing strong growth in China and India have contributed to an upsurge in oil and other commodity prices. Given these potentially inflationary late-cycle pressures, the continuing fall in UK bond yields is truly remarkable.

There was a much larger decline in corporate bond yields from 6.8 per cent in January 2000 to 4.6 per cent in mid 2003, but that was unsurprising. The world economy went into recession in 2001 and recessions are usually good for bonds. Oil prices were around £30 a barrel, less than half today's levels. The dot-com boom had ended and investors escaping from risky equities moved into bonds, driving prices up and yields down.

But what can explain the more recent steady downward trend in corporate bond and gilt yields?

One common explanation is that pension funds have been buying gilts following legislation that obliges them to reduce their deficits.

The emergence of large deficits under the new FRS17 accounting standard has also caused pension funds, it is said, to rebalance their asset portfolios. They have sold equities and bought bonds to reduce the risk of these deficits recurring.

Because pension fund liabilities are measured by discounting future expected pension payments at an AA-grade corporate bond rate of interest, the fall in bond yields would, other things being equal, make pension deficits worse. It is for this reason that pension funds are sometimes accused of making a rod for their own backs by switching into bonds.

Some argue that the desire to stabilise pension fund deficits by reducing the exposure to equities has resulted in higher deficits, as bond purchases have driven yields, and hence the relevant discount rate for liabilities, downwards.

However, the evidence for such a causal link is weak. There is nothing particularly new about British pension funds shifting into bonds. It is a natural consequence of an ageing population. Even if there has been an acceleration in this shift (possible, but by no means certain), the effect on global bond markets would be negligible.

The main influence on bond markets over the past 15 years has been the remorseless reduction in inflation and in inflationary expectations.

The worldwide shift to independent central banks has been one cause of this. The continuing fall in the price of manufactured goods from the newly industrialised countries (notably, but not exclusively, China) has been another. The downward pressure on wages in the main industrialised countries as a result of immigration (from the south in the US and from the east in Europe) is a third cause.

These are powerful forces. Just how powerful is revealed by the continuing fall in bond yields at a point in the economic cycle when they would normally be expected to rise.

The behaviour of the pension funds, although it may reinforce the decline in yields, is really only a sideshow.

Bill Robinson is director of economics at PricewaterhouseCoopers

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
News
Andy Davidhazy at the beginning (left) and end (right) of his hike
video
News
Taylor Swift is applying to trademark song lyrics from 1989
people
Voices
The popularity of TV shows such as The Liver Birds encouraged Liverpudlians to exaggerate their Scouse accent
voicesWe exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor
Life and Style
Parker says: 'I once had a taster use the phrase 'smells like the sex glands of a lemming'. Who in the world can relate to that?'
food + drinkRobert Parker's 100-point scale is a benchmark of achievement for wine-makers everywhere
News
i100
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Retirement Coordinator - Financial Services

Negotiable: Recruitment Genius: To provide a prompt, friendly and efficient se...

Recruitment Genius: Annuities / Pensions Administrator

Negotiable: Recruitment Genius: You will be the first point of contact for all...

Ashdown Group: HR, Payroll & Benefits Officer - Altrincham - up to £24,000.

£18000 - £24000 per annum + benefits: Ashdown Group: HR, Payroll & Benefits Of...

Ashdown Group: Learning and Development Programme Manager

£35000 - £38000 per annum + benefits : Ashdown Group: A highly successful, int...

Day In a Page

Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat
Saudi Arabia's airstrikes in Yemen are fuelling the Gulf's fire

Saudi airstrikes are fuelling the Gulf's fire

Arab intervention in Yemen risks entrenching Sunni-Shia divide and handing a victory to Isis, says Patrick Cockburn
Zayn Malik's departure from One Direction shows the perils of fame in the age of social media

The only direction Zayn could go

We wince at the anguish of One Direction's fans, but Malik's departure shows the perils of fame in the age of social media
Young Magician of the Year 2015: Meet the schoolgirl from Newcastle who has her heart set on being the competition's first female winner

Spells like teen spirit

A 16-year-old from Newcastle has set her heart on being the first female to win Young Magician of the Year. Jonathan Owen meets her
Jonathan Anderson: If fashion is a cycle, this young man knows just how to ride it

If fashion is a cycle, this young man knows just how to ride it

British designer Jonathan Anderson is putting his stamp on venerable house Loewe
Number plates scheme could provide a licence to offend in the land of the free

Licence to offend in the land of the free

Cash-strapped states have hit on a way of making money out of drivers that may be in collision with the First Amendment, says Rupert Cornwell
From farm to fork: Meet the Cornish fishermen, vegetable-growers and butchers causing a stir in London's top restaurants

From farm to fork in Cornwall

One man is bringing together Cornwall's most accomplished growers, fishermen and butchers with London's best chefs to put the finest, freshest produce on the plates of some of the country’s best restaurants
Robert Parker interview: The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes

Robert Parker interview

The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes
Don't believe the stereotype - or should you?

Don't believe the stereotype - or should you?

We exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor
How to make your own Easter egg: Willie Harcourt-Cooze shares his chocolate recipes

How to make your own Easter egg

Willie Harcourt-Cooze talks about his love affair with 'cacao' - and creates an Easter egg especially for The Independent on Sunday
Bill Granger recipes: Our chef declares barbecue season open with his twist on a tradtional Easter Sunday lamb lunch

Bill Granger's twist on Easter Sunday lunch

Next weekend, our chef plans to return to his Aussie roots by firing up the barbecue
Joe Marler: 'It's the way I think the game should be played'

Joe Marler: 'It's the way I think the game should be played'

The England prop relives the highs and lows of last Saturday's remarkable afternoon of Six Nations rugby
Cricket World Cup 2015: Has the success of the tournament spelt the end for Test matches?

Cricket World Cup 2015

Has the success of the tournament spelt the end for Test matches?
The Last Word: Justin Gatlin knows the price of everything, the value of nothing

Michael Calvin's Last Word

Justin Gatlin knows the price of everything, the value of nothing