The decline in yields, and corresponding appreciation in gilt prices, has been dramatic. From 7.65 per cent a year ago they have fallen to less than 6.5 per cent, the lowest level since the mid 1960s. Despite a little profit-taking yesterday, sentiment remains upbeat. About half the decline has taken place during the past month, not least because of the notion that the Government is about to embrace the single currency and that UK bond yields will therefore continue to fall towards German levels.
Before getting too carried away, it ought to be pointed out that in real terms gilt yields are still relatively high, for inflation remains at around 3 per cent. Unexpectedly high inflation meant yields were negative for much of the 1970s. All the same, it is probably sensible to assume that gilts will continue to perform well. There are all sorts of reasons for this.
First, the conduct of UK monetary policy should start reaping a reward in terms of higher credibility. The record of the past five years and the new Government's decision to make the Bank of England operationally independent have probably not been reflected fully in gilts so far. Second, Gordon Brown is proving himself to be serious about public expenditure control. The outlook for the PSBR is better than under the previous government, so a shrinking new supply will help support the price of gilts.
Third, hard as it is to penetrate the veils of rumour and leak with which the Government likes to surround itself, it is a good bet that ministers are indeed warming to the single currency. Whatever the truth behind the spin, UK yields are still bobbing around well over 100 points above German ones. That leaves a lot more potential for euro-convergence.
Then finally there is the fact that as the big pension funds mature, and begin to pay out more than they are getting in, they are naturally driven towards bonds - so much so that the question perhaps ought to be asked whether there is any possibility of the traditional relationship between the yield on equities and gilts reversing once more. Throughout the 1930s,1940s and most of the 1950s, equities yielded more than gilts. There were good reasons for this. Dividends were falling and quite a lot of companies went bust. In the deflationary environment of the time, gilts seemed a much safer investment bet and came to command a premium.
It took George Ross Goobey, then head of the Imperial Tobacco pension fund, to reverse this perception and reinvent the cult of equity. Over the long term, he rightly predicted, equities would always outperform fixed-rate gilts because dividends would grow at least in line with the economy and in many cases a good deal faster. The relationship switched and what is confusingly known as "the reverse yield gap" has persisted ever since. Are we about to see another seismic shift of this sort, with gilts once more commanding a premium over equities?
In the absence of war or depression, this seems extremely unlikely. For more than 20 years, gilts have been slowly narrowing the gap with equities, but not by much. Most of the time the gilt and equity markets move in tandem, so that if the yield on gilts falls, the yield on equities does too. Even so, the abolition of tax credits on dividends, and the need to shift into income yielding investments, are driving the pension funds more in the direction of bonds than at any time since the 1940s. All of which suggests that yields have a bit further to fall yet.