View from City Road: A gilt-edged view of inflation

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Was 1993 the year that the UK finally conquered its addiction to inflation? The quite spectacular performance last year of the gilt market, almost entirely in the second half, suggests that it has.

At the beginning of 1993 yields on 10-year bonds stood at almost 9 per cent, much the same as they had been when sterling fled the ERM in September 1992. Last night the yield was down to 6.4 per cent, its lowest level since the mid- Sixties.

Compared with yields on index- linked bonds, this means investors suspect UK inflation will be in a historically low range of 3 to 3.5 per cent, not just next year but well into the next century.

This perception, strongly reinforced by the extreme fiscal rectitude of Kenneth Clarke's November Budget and surprisingly low inflation figures since then, also helps to explain another startling statistic. Twelve months ago UK government long-term bonds yielded 1.5 percentage points more than German government bonds.

Yesterday the gap was down to less than half a point, a clear measure of the shift in attitude to the relative standing of the UK in financial markets.

In the past, bond yields have fallen during a recession but only temporarily, as a sluggish economy began to wreck public finances. Increasingly convincing prospects for non-inflationary, if modest, growth mean that this is a lot less likely to happen now.

Such a scenario, which has brought in foreign investors in droves, also helps to explain why equity markets have been happy to ride along on the gilt market's coat-tails in 1993. Equities, underpinned by falling gilt yields and hopes of steady dividend growth into the recovery, have not quite matched the near 30 per cent returns on gilts in the past year and have scope to catch up.