Inflation threatens safe-haven Britain

Britain is in no immediate financial threat, said George Osborne in his speech to the House. It was a firm restatement of the position he established in an article for the Telegraph earlier this week. Most importantly he said, the markets look favourably on Britain’s recovering public finances and the liquidity of British banks.
 
Meanwhile, economic convulsions continue outside the chamber amid marked unease about France’s AAA status and the apparent global slowdown. Despite yesterday’s vote of confidence from credit rating agencies, France’s CAC 40 has fallen today (at the time of writing). Predictably, French banks and financial institutions fared worst; with Soc Gen, Credit Agricole, Axa and BNP Paribas. For the second consecutive day, the cost of insuring these institutions against default has increased: credit default swaps have widened significantly. Analysts and commentators are convinced that a credit downgrade is a matter of time; such an event would be catastrophic, especially as the euro remains so delicate and global recovery so fragile.
 
But, as worries spread, it should be noted (as Osborne did) that markets currently see Britain as a safe haven — thanks, presumably, to the action taken on the deficit. Yields on government gilts have fallen to record lows of 2.47 per cent on 10-year money: the consequence of an increased volume of gilt purchases. The scramble to buy British government debt was evidenced today when the auction of £825 million of debt was covered 1.85 times (ie, the government received bids totaling £1.528,808 billion). However, as this Citywire article points out, yields are now so low that the real value of gilts will enter negative territory unless inflation returns to target levels in the near future. The markets will turn against Britain unless that happens, so inflation should be a growing headache for Osborne and the man tasked with controlling it, Mervyn King.