The gilt is off the government bonds

Ian Cowie

Last month, for the first time in 15 years, a fixed-interest gilts auction failed to attract sufficient subscribers.

Last month, for the first time in 15 years, a fixed-interest gilts auction failed to attract sufficient subscribers. This should serve as an alarm bell for all sorts of sterling-based investors. With little more than a year left before the next general election, the scene is set for this Labour Government – like so many of its predecessors – to end with a currency crisis.

While an embarassingly public disagreement between Mervyn King and the Prime Minister was the proximate cause for buyers to shun gilts, and the pound to enjoy a bit of a rally in March, the medium-term outlook is dire. The danger for anyone with sterling-denominated assets is not the risk that ‘quantatitive easing’ will fail to avert deflation, but the probability that it will debauch the currency.

Worse still, this dismal result will have been achieved at enormous cost. The Government’s decision to buy its own debt at near all-time high prices after warning the market well in advance may well result in even greater losses than when it sold half our gold reserves in a similarly maladroit fashion at the bottom of the bullion cycle.

With the budget deficit expected to exceed £77 billion, no wonder foreign exchange traders are forecasting hyperinflation and that international investors recoil from fixed-interest gilts. But that’s enough howling at the moon. The obvious next step for investors is to boost exposure to foreign currency assets and given the global search for income in a low-interest environment, those that can deliver a decent yield are likely to do best.

Because deficits and debt mar American prospects as much as our own, less obvious economies may provide the answer; albeit with apparently higher risk. The M&G Emerging Markets bond fund may appeal to speculative income-seekers willing to see more than a tenth of their money invested in Mexican paper and almost twice as much in Brazilian debt in return for a yield of just over 5.5 per cent. Memories of defaults in Latin America may be assuaged by having the experienced hand of Jim Leaviss on the helm.

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