New figures have shown that international investors bought a record £28.87 billion of UK gilts in October and November of last year; the highest two month figure since the Bank of England started to collect data in 1982.
Demand
Demand for UK gilts has been increased partly due to the Bank’s program of Quantitative Easing (QE) as well as with the Eurozone crisis, which has caused investors to see the UK, which still has a AAA credit rating and is outside the Euro, as a safe haven.
Many investors are concerned about the stability of European banks and the low interest rates currently on offer, UK gilts are clearly seen by investors as providing the security they desire, whilst also offering a generally better yield than simple bank deposits.
John Wraith, fixed income strategist at BofA Merrill Lynch, said: “The UK is attractive to international investors because it is outside the Eurozone. They have been reassured by the government’s determination to be fiscally responsible and see the UK as a stable and safe place to invest.”
Borrowing costs
The spike in demand for gilts has seen the UK government’s borrowing costs fall to levels not seen since the 1890’s.
The UK’s 10 year borrowing costs are now around 2% per year, similar to those of Germany, the economic powerhouse of Europe. Compare these to Spain and Italy, who are paying around 7% and 5% each year to borrow money over the same time period.
The situation is likely to continue too, the Financial Times New Year Survey showed that leading economists though the UK’s borrowing costs would remain low in 2012.
All very well you might say, but this affects your personal finances, probably more than you realise.
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How does this affect you?
First and foremost the lower borrowing costs of the UK government mean, in general terms, that the government has needed to make less cuts.
Think of it like your own household finances, if your mortgage lender increases interest rates, you may have to increase your income or reduce expenditure to cover the increased costs, the government is no different.
Whatever political persuasion you are from, most people will agree that low borrowing costs are a good thing for the UK.
But it isn’t all good news, particularly if you are approaching retirement.
The majority of people use an Annuity to convert their pension into an ongoing retirement income, other options are available of course but the Annuity is certainly the most popular choice.
In simple terms the Annuity providers buy gilts to back the income guarantees they make to people who buy their Annuities. When gilt yields fall, as they have done over the past year, so do Annuity rates; an Annuity rates comparison, using our benchmark Annuity, shows a fall of around 11% over the past six months.
Income Drawdown has traditionally been the most popular alternative to an Annuity, but even this option is affected by falling gilt yields.
The maximum income which can be taken from an Income Drawdown plan is set with reference to the 15 year gilt yield; as we know yields have fallen dramatically in recent months, meaning potentially large reductions in the income levels which can be taken from Income Drawdown plans. Existing Income Drawdown investors will not be affected until their next compulsory review; however an immediate informal review with an IFA in conjunction with the pension drawdown provider is probably sensible to plan for any future reduction in income.
Falling gilt yields means those people looking to Income Drawdown as a way of taking more income from their pension than they could otherwise get from an Annuity will also be disappointed.
Many other retirement income options, such as a Fixed Term Annuity or Phased Drawdown, have also been negatively affected by the dramatic fall in gilt yields.
There is no disputing the popularity of UK gilts, Elisabeth Afseth, fixed income strategist at Evolution Securities, said: “The UK bond markets have never seen it so good. Some of the world’s biggest funds are now buying gilts as they like the UK and the policy of the government.”
All good things come to an end, as night follows day, bear markets follow bull markets and investors should be wary of jumping on the gilt bandwagon. Any rise in interest rates generally or a worsening of the UK economic situation, leading to concerns over the country’s stability, could cause problems for gilt investors.
Despite the popularity of gilts in recent months, the need for a diversified portfolio of assets is still as valid as it ever was.
Whilst the popularity of UK gilts will put a smile on the Chancellor’s face, there is no doubting it is a mixed blessing for investors, savers and retirees alike, who are all affected in different ways by the UK’s current standing as a ‘save haven’.
