Over the past year, the British Government has had the luxury of funding its still very high borrowing requirement by issuing gilts at exceptionally low yields. That is largely because other countries, most obviously those in ‘peripheral’ Europe are seen to be much higher risk than the UK. Even the French government is paying 1% more for 10- year borrowing, while the German government is paying only 0.3% less. Of course, the UK authorities have pledged themselves to austerity with regard to public sector finances and it is undoubtedly helpful that the UK’s banking crisis emerged earlier than those elsewhere. So, the mea culpa strategy has paid off.

At the same time, it is interesting to speculate what would have happened had the Monetary Policy Committee not been so enthusiastic about quantitative easing. During the financial year 2009/10, when the larger part of QE was undertaken, the government sold £211bn of gilts, net of redemptions. Of this total, £184bn was purchased by the Bank of England. So, the actual funding requirement was actually quite light, with net sales to the market being the lowest since 2002/03. In 2010/11, there was no further QE. While gilt sales of £128bn were achieved reasonably comfortably, this was with the help of £55bn of buying from overseas. Meanwhile, although gilt yields fell during the year, the rate on 10-year maturities of 3.7% at the end of March 2011 was only 0.2% lower than that at the start of the financial year.

The twelve months to March 2012 saw a much more substantial yield decline, to just 2.1%. Again, however, the sales schedule was noteworthy for the dominating presence of the Bank of England, with the reopening of the QE programme meaning that it accounted for £105bn of £130bn of total net sales. Alongside the Bank, overseas buyers remained a highly visible presence, making £47bn of purchases.

Would gilt yields be as low now had the Bank of England not made purchases on such a massive scale? Almost certainly not – although it is difficult to determine how much higher they would be. Nonetheless, we find it very reassuring that the non-bank private sector in the UK made net sales of gilts of £23bn last financial year. In the recent few weeks, as the crisis in the Eurozone has intensified, yields have fallen even further, to a low of 1.5% and, at the time of writing 1.7%. Against this backdrop, it is to be hoped that UK holders of government debt have lightened their loads even further.

Cheap funding for the government is clearly an attractive proposition, but for investors in longer term debt, there is an uncomfortable promise. The Treasury has mandated the Monetary Policy Committee to keep inflation at 2%. In fact, the MPC has been rather unsuccessful in the brief, with inflation being at a rate somewhat higher than target for a prolonged period. But let us suppose that the MPC fulfils its mandate. The Treasury’s promise to buyers of 10-year gilts is that after adjusting for the impact of inflation they will lose money in total return terms. As to the proposition that at least you will get your money back at the end of the day, even this is not correct, since most gilts are priced above par.

The financial crisis in Europe has, I believe, caused huge mispricing of supposedly risk- free assets. But the extreme risk aversion that is reflected in high-quality bond markets is opening up opportunities for investors who have more normal attitudes to risk. The market equity portfolio in the UK currently yields 3.7%. Even with no capital gain, this is a substantially better proposition than the government is offering.