For the first time in a couple of years, the yield on British 10-year gilts overtook their French equivalent – but does this mean that France is a better bet?
Anglo-French relations looked likely to flare up again on Friday when investors pushed UK government bond yields above their French equivalent, suggesting Britain was a riskier bet than France.
For the first time in a couple of years, the yield on British 10-year gilts – the effective interest rate on government debt – overtook their French equivalent. Chancellor George Osborne will be relieved to hear they have since slipped back and normality has been restored.
But does this mean that France is a better bet, or at least as good a bet as the UK, in terms of paying back its debts? Analysts say no, and not only out of a sense of national pride. Credit default swaps (CDS) – which traders use to bet on a country’s creditworthiness – barely moved on Friday morning, and told a very different story.
Although they are often referred to as an insurance policy against a company or country defaulting, CDS are frequently used to bet that a company or country will default (or that its credit rating will decline) rather than to protect against any losses if it does. Investors pay a fee to hold a CDS and receive a payout if the company or country defaults – but they need not own any of the debt, so could simply buy the CDS in the hope a default will trigger a windfall.
According to the CDS market, the cost of insuring against the risk of a French default is currently double the cost for Britain. Mark Dowding, co-head of investment grade credit at hedge fund Bluebay Asset Management said: “From a pure credit risk standpoint, France is deemed to be about twice as risky as the UK.”
He said that is generally the case because the UK can control its own currency. “If we were in a position where we were struggling to meet our bills, the government could print money.” That means the UK is seen as less of a credit risk, but has a greater risk of surging inflation. “In the eurozone, because the Bank of France can’t start printing euros if it gets into trouble and can’t meet its bills, it is less of an inflation risk but more of a credit risk.”
So what was going on with bond yields on Friday morning? Dowding says it was simply a question of supply and demand. The Bank of England holds about 40% of gilts in the market following the quantitative easing programme, which saw it pump money into the economy by buying up government bonds. Recent news has suggested it may be stepping back from this particular programme, which has sent gilt prices down and yields up. In France, meanwhile, bond yields move in line with German bond yields. And these have been edging down over the past few months as the threat of an imminent break-up of the eurozone has receded.