U.K. Bond Yields May Rise as Investors Shun Deficits, BOE Says

By Brian Swint and Gavin Finch

Sept. 21 (Bloomberg) -- Bond yields in countries such as the U.K. and the U.S. may rise as investors shun the debt of nations with large trade deficits, the Bank of England said.

“To the extent that savers in surplus countries may become more reluctant over time to invest funds in deficit-country government bonds, this would tend to raise the cost of borrowing in deficit countries,” the central bank said. “This shift in the relative cost of borrowing could be an important part of the process by which a rebalancing of demand from deficit to surplus countries is achieved over the medium term.”

The financial crisis has started to reduce the trade gap with surplus countries such as China by lowering domestic demand and prompting the depreciation in sterling and the dollar, the central bank said in a paper co-authored by former Lehman Brothers Holdings Inc. Chief European Economist Michael Hume. The structure of global demand will probably have to change more, the bank said.

Global imbalances may have exacerbated the financial crisis that sparked the biggest global economic slump since World War II. While the U.K. central bank has kept a lid on gilt yields by pledging to buy 175 billion pounds ($285 billion) of bonds to spur growth, it will likely sell those assets when the economy recovers, exacerbating any increase in borrowing costs.

The Bank of England published the paper in its quarterly bulletin, which also featured research saying that the dollar’s depreciation may have stoked demand for corporate bonds, stocks and “other risky asset prices.”

The U.K. current account deficit has narrowed from a record in September 2007, helped by the 30 percent drop in the pound in the period.

“Sterling’s depreciation may be part of a more prolonged process of rebalancing of the U.K. economy, generating a fall in the long-run sustainable real exchange rate,” the bank said in another article on the movements in the pound’s value.

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net.