- Joined
- Apr 27, 2010
- Messages
- 86
- Points
- 0
A country’s solvency relies on an economy’s ability to generate growth, and its government’s ability to deliver primary surpluses. The U.K. government has a lower debt servicing burden than most of its European neighbors. But the country will face much stronger headwinds to future growth and it also has a poor record in producing primary surpluses.
Putting this together, it is clear that the solvency of the U.K. is not materially different to that of Italy or Spain – and considerably worse than the solvency of the euro area in aggregate. However, the bond market is not priced accordingly: 7-10 year sovereign yields trade at 1.5% in the U.K. compared with 5% in Italy and Spain and 2.5% for the euro area weighted average.
Until recently, there has been a very good reason for this polarization in yields. The U.K. sovereign has a lender of last resort – the Bank of England – which has been aggressively buying U.K. gilts. In contrast, the Italian and Spanish sovereigns did not have such a backstop, making them victims of a classic liquidity crisis. But with the ECB’s pledge to “do whatever it takes”, the mispricing of sovereign risks in Europe should now gradually correct.
BCA
Putting this together, it is clear that the solvency of the U.K. is not materially different to that of Italy or Spain – and considerably worse than the solvency of the euro area in aggregate. However, the bond market is not priced accordingly: 7-10 year sovereign yields trade at 1.5% in the U.K. compared with 5% in Italy and Spain and 2.5% for the euro area weighted average.
Until recently, there has been a very good reason for this polarization in yields. The U.K. sovereign has a lender of last resort – the Bank of England – which has been aggressively buying U.K. gilts. In contrast, the Italian and Spanish sovereigns did not have such a backstop, making them victims of a classic liquidity crisis. But with the ECB’s pledge to “do whatever it takes”, the mispricing of sovereign risks in Europe should now gradually correct.
BCA
