In a sense, such buying is a form of quantitative easing. When foreigners buy gilts from UK residents, they hand over cash to us, which we can spend on other assets. And such buying helps to reduce gilt yields. These are the same effects that Bank of England buying of gilts is supposed to have. As many small developing countries have discovered down the years, a capital inflow is in some ways similar to a domestic monetary expansion; it increases both asset prices and residents' cash holdings. The difference is that whereas the Bank of England's quantitative easing helped to hold sterling down insofar as it increased the money supply, foreign buying of gilts helps to support sterling by raising the demand for UK assets.
But why has there been such big buying? It's not entirely because foreigners have confidence in the new government's determination to cut borrowing; their buying was actually greater in March and April, before the election, than it was immediately afterwards.
Instead, there are three other factors at work. One is that the global savings glut, or investment dearth, has continued. Asian and middle eastern savers have been looking for safe havens for their savings, and regard gilts as one such.
Also, the euro zone debt crisis has encouraged some investors to dump Spanish, Irish, Greek and Portuguese bonds and to switch into safer ones.
Thirdly, the ending of the Bank of England's quantitative easing encouraged net foreign buying; you can see from my chart that such buying declined in 2009 as QE began. The reasoning here is simple. When the Bank of England bought gilts, someone had to sell. And that someone was, in part, the overseas investor. Their selling was either direct to the Bank, or indirect; a UK investor who sold to the Bank used the cash to buy other gilts from foreigners. In this sense, QE by the Bank of England and QE by foreigners are, in part, substitutes; more of one means less of the other.
Herein, though, lies a problem. It's possible that 2011 will see less foreign buying, if the savings glut/investment dearth subsides and if reduced nervousness about euro zone debt causes a flight from quality; it might be no accident that November saw the lowest foreign buying of gilts (£3.26bn) since June.
In such an event, we might finally discover how confident investors really are about the outlook for UK government debt.
* The figures are in table A3.2 of Bankstats.
