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No Greek contagion in gilts

Created:

9 February 2010

Updated:

10 February 2010

Written by:

Chris Dillow

The gilt market has not suffered as a result of investors' worries about Greek government debt. Today's auction of £2bn of 2034 gilts went well, with the DMO receiving £4.15bn of bids for the £2bn of stock on offer.

Granted, the spread between 10-year gilts and their German counterparts has widened. But it has only returned to its pre-credit crunch levels. And it has done so only because bund yields have fallen - perhaps because of worries about the euro zone economy, as well as the hunt for a safe haven from Greek bonds - rather than because gilt yields have risen. Indeed, 10-year yields are now slightly lower than they were at the turn of the year.

This is comforting. Very often, if one particular asset gets into trouble, investors sell assets they perceive to be similar; this is the story of the Asian financial crisis of 1997-98 and of many sell-offs in emerging market equities. It's called contagion. And although Portugal and Spain have suffered a little of this, the UK has - so far - been immune.

One reason for this is that the market recognizes that the UK and Greece are very different. There's a world of difference between the danger of a bond losing its BBB status, and the danger of one dropping from AAA to AA status. The former would mean that Greek bonds will no longer be accepted by the ECB as collateral against the money it loans to banks, which would greatly reduce the liquidity of the bonds. The latter, though, is a difference of only a "small degree."

Also, the gilt-bund spread depends not merely - or even mainly - upon credit risk, but upon inflation and currency risk. If markets expect the UK to have higher inflation, or a weaker currency, than the euro zone, the gilt-bund spread will widen. However, Greece's troubles have not added to the relative risks to UK inflation or to sterling, so there's no reason for gilts to sell off, relative to top-grade euro zone bonds.

Of course, things could change. There might come a time when markets do worry seriously about the UK's creditworthiness. But that time is not now.