Fiscal concerns trouble bond markets (Dec 09)

The Chancellor’s projections for borrowing and debt in the Pre-Budget Report failed to reassure markets that the public finances are back on a path to fiscal sustainability. In response, gilt yields edged higher. Meanwhile, credit default swaps on government debt in the UK and elsewhere rose further amid the fallout from the turmoil in Dubai and Greece. But, in the UK at least, markets seem unduly worried. All political parties have accepted the need to make deep cuts to public spending after next year’s general election. And the weak recovery, due in part to the forthcoming fiscal tightening, is likely to mean that a great deal of slack remains in the economy, keeping inflation low. As a result, we doubt that fiscal concerns will prevent gilt yields from falling further next year.