Bank of England figures on gilt purchases cast doubt on Chancellor George Osborne’s claim that record low yields represent a vote of confidence in the UK’s economic and fiscal fundamentals. Yields, instead, have been driven down by a combination of QE, regulatory-inspired bank buying and capital flight from the Eurozone (i.e. a loss of confidence in competing markets).

In November alone, the Bank bought £23.9 billion in QE operations while overseas investors ploughed £16.3 billion into gilts – just below a record £16.6 billion in September 2008, when Lehman failed. With the Debt Management Office (DMO) issuing “only” a net £11.9 billion, official and foreign demand was sated by UK non-bank investors and banks selling on a large scale – reflecting, presumably, a judgement that yields were artificially and unsustainably low. UK non-banks reduced their holdings by a record £23.1 billion in November following a £16.7 billion disposal in October.

The dominant role of policy-related and foreign buying is not new but is reflected in figures covering 2009-11 (i.e. up to November, a period of 35 months) – see chart. The DMO has issued a net £475.1 billion of gilts since the start of 2009 – equivalent to a third of annual GDP. The Bank has hoovered up £240.9 billion of this flow leaving £234.2 billion – less than half – to be absorbed by “the market”*. Capital flight from the Eurozone contributed to foreigners buying £153.8 billion with the remainder absorbed by UK banks, largely reflecting regulatory pressure to increase holdings of “high-quality” liquid assets. Despite the supply avalanche, therefore, UK non-bank investors – the traditional buyers of gilts – have actually reduced their holdings, by £6.1 billion, since the start of 2009. They bought £37.2 billion in the prior three years (i.e. 2006-08).

With conventional market drivers suppressed by price-insensitive official and foreign demand, the key determinants of whether / when yields will recover will be QE and regulatory policies and the success or failure of Eurozone stabilisation efforts. UK economic and fiscal trends, as well as rating agency decisions, are probably of second-order importance.

* It would have been more efficient for the DMO to issue directly to the Bank at the then-prevailing market prices but this would have made explicit the monetary financing of the budget deficit (as well as denying gilt market-makers a profitable arbitrage between the two public sector bodies).