British bonds stirred but not shaken

UK bond market isn’t in crisis despite the rise in gilt yields, and the performance is not that different from most G7 countries

Question: which G7 economy on Monday saw its 10-year bond yields trade at levels higher than on 23 June, the day of the UK’s referendum? Despite the sudden panic about “soaring” gilt yields and thus the rise in the government’s cost of borrowing, the answer is not the UK. It is the US.

The question is a slight cheat in the sense that US 10-year Treasury yields have barely budged – they were 1.74% on referendum day, fell to 1.32% in early July and are now 1.76%. But a comparison with the US makes a useful point. The UK’s journey from 1.37% to 0.5% to 1.11% can be made to resemble a screeching handbrake turn because yields have doubled from their low point. But, viewed in the round, gilt yields haven’t strayed very far from the curve taken by most G7 countries’ bond markets since the summer.

Even Germany’s 10-year bund rates, as Oxford Economics points out, are close to their pre-UK referendum levels – albeit Germany’s cost of borrowing for 10 years is close to zero.

The thinktank offers other reasons to be sanguine about gilt yields. For example, the UK’s cost of borrowing is still remarkably low. Over the past 80 years, UK governments have paid an average of 6.4% to borrow for a 10-year period, it calculates. We will discover next month how much chancellor Philip Hammond intends to borrow to spend on infrastructure and suchlike, but it would be amazing if he has altered his plans because of the up-tick in gilt yields in the past three weeks.

Indeed, gilts always have to be viewed against the backdrop of inflation expectations. As the pound has fallen, so have investors naturally come to predict a higher rate of inflation in the UK over the next decade. But the government can still borrow well below the expected rate of inflation of 3%.

It would be ridiculous, of course, to assume conditions will remain so benign forever. There are dangers from many directions. A further downwards lurch for the pound, an inflation shock (September’s data will be published on Tuesday), or a Brexit-related collapse in business investment could all upset investors’ appetite for gilts. But let’s at least use a sensible definition of what would represent a crisis: a yield of 1.11% is not even close.

Poorer Pearson?

Pearson is testing the faith of its loyal shareholders. A 13% fall in North American revenues was a scary-looking figure to unveil at the nine-month stage, even if it looks much gentler in sterling terms.

Don’t worry, says chief executive John Fallon, there’s an explanation. Bookshops at US university and college campuses have been running down stocks of textbooks to get their inventories under control. When that period passes, Pearson will be seen to have suffered merely a slight hiccup.

For the time being, hope is alive – as are this year’s earnings forecasts. The entire US education market has been moving to digital formats and Pearson has tried to get ahead of the trend by cutting 4,000 jobs, 10% of its workforce. It would not be surprising if campus bookshops have been slower to react and are now adjusting in haste.

Yet the nagging doubt is whether the digital drift will leave publishers permanently poorer in a world where students have gained the ability to rent materials, for example. Fallon needs to show that Pearson can still grow sales in the US college market. Judgment day arrives next year.

If all goes to plan, operating profits will improve from about £600m this year to £800m in 2018. Terrific if it happens because a dividend yielding almost 7% would look considerably safer. Monday’s 8% fall in the share price says the market remains sceptical.

Biffa cuts and floats

Biffa’s private equity backers were clearly extremely anxious to see the waste management firm floated. They agreed to cut the price of the shares to 180p from a reputed 220p-270p. And, instead of selling a few shares themselves, the owners have ended up increasing their investment. Current shareholders chipped in £50m of the £262m raised by Biffa.

In the shoes of Bain Capital, Angelo Gordon and Avenue Europe, you might be tempted to ask for a refund from your battalion of bankers on the float – Citi, JP Morgan, HSBC, Peel Hunt and Rothschild. No chance. The prospectus reveals the expected expenses of the offer will be £19.6m – call it a 9% rake-off from the new shareholders’ £212m. Where’s there’s muck, there’s brass, they say – but that’s going some.


Nils Pratley

The GuardianTramp

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