Roll up, who wants to lend to the UK government for three years for zero interest?
Lots of people. The debt management office – a busy place these days – shifted £3.8bn-worth of three-year gilts on Wednesday at a yield of -0.003%. If buyers hold their paper for the full three years, they will get back sightly less than they invested.
At one level, the government will cheer. If, like the chancellor, Rishi Sunak, you are amassing unheard-of levels of debt to pay for the Covid-19 crisis, it’s clearly helpful that investors are willing to pay, in effect, for the privilege of owning your IOUs. It’s an easier problem to face than being bullied by the bond market, which is what old economic textbooks might say should be happening when public borrowing has gone through the roof.
But it is still a problem: the message is unmistakably bearish for the economy. Inflation in April fell to 0.8%, and the bond market clearly believes the recession will be so severe the rate will go lower yet. In effect, investors are questioning the UK’s ability to generate inflation, at least in the short-term.
They are also doubting the Bank of England’s ability to resist cutting interest rates, currently 0.1%, to below zero. The governor, Andrew Bailey, is a sceptic of negative rates for the understandable reason that they risk messing up the banking system, which has to maintain vast holdings of government debt for capital and liquidity purposes. But the European Central Bank and the Bank of Japan went negative even before the coronavirus. It could happen here if the downturn is even worse than predicted.
The medium-term inflationary picture could also turn out very differently, of course. A global recession caused by a pandemic is unknown territory. If the first effect is deflation, the second could be inflation. Massive government spending programmes could provoke a surge in demand that beaten-up producers suddenly find themselves unable to meet. Look at oil prices as a possible early indicator – they’ve stopped falling (at least for now).
Investors know that parallel risk, of course, just as they can assume that governments would happily seize any opportunity to inflate away some debt by turning a blind eye to returning inflation. It’s been done in the past.
But that is also why the bond market’s current willingness to lend at 0% for three years is so alarming. The rush for safety is signalling that the crisis could get worse, and that remedies could take years to be effective.
The stock market is singing a far more cheerful tune, it should be noted. It’s almost perky and still seems to believe in something vaguely resembling a V-shaped recovery. But they can’t both be right.
Manufacturing sector is at the crisis’ next stage, but where’s government?
Unite, the union, called the 9,000 job losses at Rolls-Royce “shameful opportunism”, a judgment that feels too harsh. The cuts are the deepest at Rolls in decades, but they are matched by the size of the crisis in the aerospace industry.
The group’s commercial aerospace division has only two main customers for its engines – Airbus and Boeing – and both are cutting production by 30%-40%. Both are also warning that it will take years for output to return to 2019 levels. And, critically, less flying means less work for Rolls-Royce in servicing engines that are already in operation. Job losses were inevitable.
Unite, though, is entirely right to demand a strategy from government to “build Britain out of this dreadful situation”, as the assistant general secretary, Steve Turner, put it. Rolls’ UK operation, especially the Derby plant, is most exposed to the cuts. The clear threat is that engineering skills are lost permanently.
There are plenty of ideas for government investment. For example: accelerate the small modular reactor programme, which uses Rolls-developed technology. If nuclear is to be part of the low-carbon energy mix, smaller plants make more sense than building another Hinkley Point C white elephant.
Government’s current concentration on furlough schemes and lending schemes is understandable. But the next stage of the crisis has arrived already in the manufacturing sector, and new and bigger thinking is urgently required. Unite’s idea for a “national council for recovery” sounds more promising than anything we’ve heard from ministers. Is the department for business, energy and industrial asleep?