Europe South Asia Asia Pacific Americas Middle East Africa BBC Homepage World Service Education

Front Page



UK Politics







Talking Point
On Air
Low Graphics

Tuesday, September 22, 1998 Published at 17:36 GMT 18:36 UK

Business: The Economy

A whiff of panic?

A bad day for shares spells a good day for bonds

Bond yields have dropped sharply across the industrialised world in the past few months and the decline appears to be accelerating.

[ image:  ]
Many analysts believe that the development is the strongest signal yet that the world economy is on the brink of a recession.

The drop in interest rates on long-term government bonds means that the markets are betting that future inflation rates will stay down at unprecendently low levels.

It is a gamble that recession, rather than inflation, is the main threat.

Flight to quality

The collapse in bond yields has accelerated in the last few weeks as investors have sought safe havens from currencies and stock markets under threat.

The greater demand for bonds has pushed up the prices, effectively lowering the interest payable on them.

But now the rush to buy bonds has pushed yields to record lows.

The US 30-year Treasury bond has moved to just above 5.16%, its lowest level ever, and German 10-year bunds are under 4%, while Japanese 10-year bonds are 0.7%.

Since investors usually want a real return of at least 3-4%, this implies that they believe inflation will be around 1% in Germany and the USA, and negative in Japan.

In contrast, bond yields in emerging markets are 18% higher on average - up from a difference of 6% a few years ago.

Deflationary worries

The development is good news for governments, who have to pay less interest on their debts. But it is worrying some analysts, who fear that it signals a severe deflation.

For most of the post-war years, we have lived with varying degrees of inflation., with prices increasing every year.

Although we have worried when prices got too high, our system is geared for some degree of inflation - most people who borrow money to buy their house are betting on some inflation, for example.

True deflation - with falling commodity prices, weak demand, and high unemployment - last occurred in the l930s, when the world entered the Great Depresssion.

Some analysts think that such a time is not too far away.

"If there is another Russia the West could be peering into the abyss of global deflation," commented Avinash Persaud head of currency research at J.P. Morgan.

Inverted yield curve: rate cuts?

Another worrying feaure of the drop in bond yields is that they have taken long-term interest rates below the short-term rates set by Central Banks.

Normally long term interest rates are higher, because of the concern that inflation would eat away at the value of money held for a long time.

An inverted yield curve, where short-term rates are higher, are normally a sign of an impending recession.

They also suggest that a reversal in policy by central banks is imminent, lowering short-term rates to bring things back into balance and stimulate the economy by making it cheaper for companies to borrow.

But at present a number of central banks are not in a position to lower rates.

Germany's Bundesbank, facing the prospect of lowering rates across Europe in advance of the single currency, is in no position to make further rate cuts.

And Japan's central bank has already cut interest rates to 0.25%. That leaves any action on rates to the US Federal Reserve Bank, which next meets on September 29.

Advanced options | Search tips

Back to top | BBC News Home | BBC Homepage | ©

The Economy Contents

Relevant Stories

02 Sep 98 | Your Money
Market turmoil: Buy, sell or panic?

28 Aug 98 | The Economy
Flight to security

In this section

Inquiry into energy provider loyalty

Brown considers IMF job

Chinese imports boost US trade gap

No longer Liffe as we know it

The growing threat of internet fraud

House passes US budget

Online share dealing triples

Rate fears as sales soar

Brown's bulging war-chest

Oil reaches nine-year high

UK unemployment falls again

Trade talks deadlocked

US inflation still subdued

Insolvent firms to get breathing space

Bank considered bigger rate rise

UK pay rising 'too fast'

Utilities face tough regulation

CBI's new chief named

US stocks hit highs after rate rise

US Fed raises rates

UK inflation creeps up

Row over the national shopping basket

Military airspace to be cut

TUC warns against following US

World growth accelerates

Union merger put in doubt

Japan's tentative economic recovery

EU fraud costs millions

CBI choice 'could wreck industrial relations'

WTO hails China deal

US business eyes Chinese market

Red tape task force

Websites and widgets

Guru predicts web surge

Malaysia's economy: The Sinatra Principle

Shell secures Iranian oil deal

Irish boom draws the Welsh

China deal to boost economy

US dream scenario continues

Japan's billion dollar spending spree