The last few days have provided a new context for the economic impact of the response to the Covid-19 pandemic. I had kept warning that the optimistic forecasts for next year were mostly based on the fumes of hopium and now it is clear that it will be a rough first quarter at least. Just like wars pandemics are supposed to be over by Christmas but seldom are. That feeds into our subject of the day which is the UK public finances which will be on a different path to the one previously expected.
Indeed that theme we could say is a different path squared as we note the way that they have changed this year already.
Public sector net borrowing (PSNB ex) in the first eight months of this financial year (April to November 2020) is estimated to have been £240.9 billion, £188.6 billion more than in the same period last year and the highest public sector borrowing in any April to November period since records began in 1993.
There were times that such numbers would strike terror around financial markets and there has been some interest in this in Parliament.
It is the latter process that Mel Stride, a Conservative MP that chairs Parliament’s Treasury select committee, highlighted in a public letter earlier this month, questioning whether the pricing of over £300bn of gilts sold through syndications since 2009 had been “keen enough in favour of the taxpayer”. ( Financial Times)
That is curious line of attack now we borrow so cheaply and it continued with this.
Mr Stride had highlighted how the size of syndication order books corralled by banks often outstrips the amount of gilts being sold — at the latest one, investors placed orders of almost £50bn for £6.5bn of gilts — and queried whether this meant they could be sold at an even lower interest rate.
What that fails to acknowledge is that there is the London Whale in the room. For example the most recent sale of UK bonds was on the 9th when some £2.5 billion of a 2035 maturity Gilt was sold and some £7.4 billion was bid for. But the Bank of England is buying around £4.4 billion a week and sophisticated traders will be using it as both a benchmark and a put option. It will not buy a newly issued Gilt for 169 hours or if you prefer a Beatles style 8 day week. But it does buy other Gilts and on the same day it bought £1.1 billion of the 2030 and 31 maturities. The exact amounts which are spread trades are hard to be precise about but they will be happening and will be inflating demand.
So are there easy profits to be made? Yes. But the committee is barking up the wrong tree as it should be interviewing the Bank of England as well, a point the Financial Times curiously omits. The bit below is on warmer ground however and regular readers will have noted me referring to this type of game theory before and it covers pretty much everywhere.
Mr Stride had also questioned whether investors and banks might have an incentive to shun gilts which new government bond sales are priced off, artificially lowering their price ahead of the syndication and therefore lift the effective interest rate the government pays.
The National Debt
This has been rising but not as much as has been reported regularly by the media so let me explain. Here is this morning’s release.
Public sector net debt excluding public sector banks (PSND ex) rose by £301.6 billion in the first eight months of the financial year to reach £2,099.8 billion at the end of November 2020, or around 99.5% of GDP; this was the highest debt to GDP ratio since the financial year ending 1962.
The media will have to be hoping people forget they said it was over 100% of GDP and now that it has grown further it is now below it. Oops! A lot of this is the fact that GDP grew strongly in the third quarter although the party will start again when it falls this quarter.
If we stay with the just over £300 billion growth then we can get a perspective by comparing it to the Bank of England purchases. The new purchases in this pandemic period total some £290 billion. This is not quite like for like as they began on the 20th of March or around a fortnight before the start of the financial year, But I am sure you get the message.
There is however something out of Alice in Wonderland in the mathematics here.
The Bank of England’s (BoE’s) contribution to debt is largely a result of its quantitative easing activities via the BoE Asset Purchase Facility Fund (APF) and Term Funding Schemes (TFS).
Neither are in fact debt but get trapped in the rules meaning this happens.
If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of November 2020 would reduce by £233.9 billion (or 11.1 percentage points of GDP) to £1,865.9 billion (or 88.4% of GDP).
Actually there is a clue provided elsewhere because if you look at the size of our debt market it is rather curiously lower than what we report as a national debt.
What is driving the latest figures?
The first factor is that tax receipt have dropped.
In November 2020, central government receipts were estimated to have fallen by £3.5 billion compared with November 2019 to £53.9 billion, including £38.9 billion in tax receipts.
Some of this is due to the fall in economic activity and some due to the VAT and Stamp Duty tax cuts. By contrast expenditure has ballooned.
Central government bodies spent £83.6 billion in November 2020, £24.6 billion more than in November 2019. Of this, £80.6 billion was spent on day-to-day activities (often referred to as current expenditure)…..The remaining £3.0 billion was spent on capital investment such as infrastructure.
Again some of the extra spending is deliberate government policy.
In November 2020, central government paid £7.2 billion more in subsidies to businesses and households than in November 2019. These additional payments included £5.9 billion as a part of the Coronavirus Job Retention Scheme (CJRS) and the Self-Employment Income Support Scheme (SEISS).
The numbers have got larger and are about to get larger still as I explained at the beginning of this piece. But we can still afford to be sanguine and let me explain why. The round-tripping between the UK debt office, the bond market and the Bank of England means that our debt costs ( interest or coupons) have fallen so far this financial year. Up until November 2019 then were £36 billion but this year they have fallen to £28.1 billion in spite of the fact the debt is much higher.
There is a catch as much of this will remain because conventional bonds have a fixed rate of interest. But index-linked bonds can get much expensive as the November data has shown today.
Interest payments on the government’s outstanding debt were £4.2 billion in November 2020, £2.1 billion more than in November 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.
That is why they plan to produce lower numbers for the RPI from 2030. But returning to now there is a risk from an episode of inflation. There is also a risk that we borrow so much that even at these yields it becomes an issue but that is still quite a way away. Also you can see that QE is forever now as the government cannot afford to let the Bank of England stop.
As a theme well these numbers do remind me of Lewis Carroll.
“Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to,” said the Cat.
“I don’t much care where—” said Alice.
“Then it doesn’t matter which way you go,” said the Cat.
“—so long as I get somewhere,” Alice added as an explanation.
“Oh, you’re sure to do that,” said the Cat, “if you only walk long enough.”