With political risk easing, UK sovereign debt is back in vogue

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fFOREIGN EXCHANGE trading is for the most part a game for young people. However, find a veteran whose memory extends beyond a few decades, and he’ll tell you there are really only two numbers that matter to the pound. Those are 1.40 and 2.00, the limits of its normal trading range against the US dollar. Since 1985, when it has hit either one, there must be a turning point (see chart).

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That was until June 2016, when Britain’s vote to leave the European Union sent the pound tumble through the floor. The fallout has kept it there ever since. Political headlines became a consistent predictor of fluctuations in the pound’s exchange rates, prompting comparisons with emerging markets. Foreign investors looked at British assets with distaste, fearing they were priced in a currency that could fall further if the most disruptive version of Brexit were to be realised. Those looking to hedge against that risk found it increasingly expensive to do so, as speculators bet the pound would take another beating.

In the event, the mauling failed to materialize. Although the trade agreement between Great Britain and the EU without funding in favor of fisheries, the transition period ended in a more orderly fashion than many had feared. As the deal came into view, bets against the pound began to settle, making it cheaper for foreign buyers to hedge currency risk on UK assets. Overseas investors poured back into gilts (British government bonds) like never before, buying a record £89.8 billion ($127.4 billion) from them in the year to April 2021. The pound even traded above $1 in the past month. 40.

Foreign enthusiasm for gilts isn’t just due to a resurgent pound. Rapid vaccine roll-out points to a faster recovery from the Covid-19 pandemic in Britain than elsewhere in Europe. That, coupled with the fact that the Bank of England is generally seen as more aggressive than the European Central Bank, means that UK government debt yields are relatively attractive. “It becomes easier to sell gold with a 0.81% return when people glance at France’s 0.17%,” said Kit Juckes of Société Générale, a bank.

Political risk remains, especially in the form of an imminent fight over Scotland’s future. But the fiscal impact of a Scottish exit on the rest of Britain would be mild and positive. In the 2019-20 tax year, Scotland accounted for 9.2% of Britain’s total government spending and about 8% of tax intake. And some of that revenue was likely to be preserved as financial firms headquartered in Edinburgh moved to London. “Hive Scotland off, and the rest of the” UK assumes a budget deficit of about 2% of GDP to one of about 1.5%,” said Thomas Pugh of Capital Economics, a consulting firm.

Things will not be smooth sailing in the coming months. A row between Westminster and Brussels over the implementation of trade rules in Northern Ireland threatens to reopen arguments that led to the Brexit withdrawal agreement. That would hurt Britain’s trade prospects. Meanwhile, the Treasury Department plans to veto the government’s stock exchange listings for national security reasons, which could diminish the attractiveness of the country’s financial markets to foreign companies. But for now, it looks like the money will keep flowing in. “We are still priced for permanent uselessness of the” UK‘ says Mr. Juckes. “There must be an opportunity there.”

This article appeared in the UK section of the print edition under the headline “Gilt-y pleasure”

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