The Chancellor George Osborne is expected to use next week's Budget to announce plans for Britain to sell "perpetuals" – loans on which the principle is never repaid, accruing interest indefinitely – or 100-year bonds.
George Parker and David Oakley report for the Financial Times:
George Osborne will say in next week’s Budget that he wants to “lock in” the benefits of Britain’s low borrowing costs, which he says reflect market confidence in his fiscal plans.
Investors, however, are divided over the bonds’ attractions. Some said they liked the idea of a safe security with a fixed interest for such a long period but others said they would be reluctant to buy such debt because of the low yields, or returns.
When an investor buys a bond, they are making a loan to the British state, which usually pays a fixed interest rate to the investor for the period of the bond. Since loans made to a nation which prints its own currency are very safe – they will be repaid in full unless Britain goes bankrupt – the interest rates paid on them are correspondingly low. Ten-year loans, or "gilts", are the benchmark, and currently command a yield of 2.17 per cent.
The longer the period of the loan, the higher the yield gets. This partially represents the increase in risk being taken on – for all that Britain going bankrupt is unlikely, it is more likely to occur in the next 30 years than it is in the next month – but it also necessarily reflects the fact that the investor could get more with their money elsewhere. The advantage for the seller, the Treasury, is that they buy greater certainty as to their income.
At the same time, both buyer and seller are engaged in a gamble as to what will happen with future interest rates. If they are likely to rise, then demand for short term bonds will outstrip demand for longer term ones. No investor wants to get locked into a 30 year bond paying interest rates of (at present) 3.24 per cent if they rocket up shortly after the contract is signed. But if they fall after a long term bond is bought, the investory is quids in, and the Treasury loses out.
So why introduce a 100-year bond now?
As the FT explains, Britain's bond yields are at a historically low level – although whether that actually represents market confidence is debated – so there is an advantage for the government in getting as many long-term loans as they can before the recovery eventually forces the rates back up. But as the BBC's Robert Peston points out, the actual market for long-term bonds is small, and shrinking; this may be little more than a stunt, a way of showing off just how credit-worthy Britain is.
If Osborne decides to introduce a perpetual rather than a 100-year bond, the stunt status seems assured. Such bonds carry the nice tradition of being named after the chancellor who issues them, ensuring a place in history, but are of little material value. For one thing, "they are excluded from many index-tracking portfolios, reducing demand"; for another, the economic phenonomen of "present value" means that their actual worth is little different from a 100-year bond.
As a result, Osborne would lose liquidity and predictability in exchange for a lot of prestige and very little extra value.