Double dip fear stalks market as gilts sink
Yields on 10-year gilts dropped to record lows as capital markets threw their weight behind gloomy predictions for the British economy and the expectation of very low interest rates for the foreseeable future.
Government bond yields fell by almost 10 basis points to an intra-day low of 2.8% following comments from Martin Weale, a newly-appointed member of the Bank of England's monetary policy committee, casting doubt on the Bank's growth forecasts for 2010 and warning of a "significant" risk of double dip recession.
Mr Weale's remarks - which play down fears of rising inflation, and therefore suggest interest rates will remain at current unprecedented lows for longer than assumed - helped push yields down to close at 2.88% per cent, the lowest level on record.
Yields on 10-year gilts hit a 16-month high in February, at the height of concerns about rising inflation, spiralling public debt and the risk of a credit rating downgrade.
But they have fallen consistently since the election, as fears of a sovereign default receded in part thanks to the coalition government's emergency Budget committing to eliminate the current structural deficit by the end of the current Parliament.
Perversely, concerns that such tough spending cuts will put a drag on Britain's economic recovery are themselves helping to cut government borrowing costs by boosting gilt prices and cutting yields.
John Higgins, the senior markets economist at Capital Economics, said: "The simplest explanation of the drop in gilt yields is a dramatic reassessment of the likely path of interest rates, and the resurgence of the view that they are not going up any time soon.
"The UK's strong economic growth in the second quarter is not indicative of what is to come - the fiscal squeeze is yet to bite and will then bear down heavily on economic activity, which will mean monetary policy will need to stay very loose."
The slide in yields also suggests capital markets do not agree with recent predictions from the Policy Exchange think-tank that interest rates could be set to rise as high as 8%.