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Green Budget: Funding Issues and Debt Management January 30 th 2008. David Miles, Chief UK Economist David.Miles@morganstanley.com Laurence Mutkin, Head of European Interest Rate Strategy Laurence.Mutkin@morganstanley.com.

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green budget funding issues and debt management january 30 th 2008

Green Budget: Funding Issues and Debt ManagementJanuary 30th 2008

David Miles, Chief UK Economist

David.Miles@morganstanley.com

Laurence Mutkin, Head of European Interest Rate Strategy

Laurence.Mutkin@morganstanley.com

Morgan Stanley does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.Please see important disclosures at the end of this report.

summary
Summary
  • Government is again likely to borrow more than forecast. But the gilt issuance environment is still favourable as yields are very low.
  • Yields on shorter dated gilts have fallen a lot. Issuance could now be less skewed towards longer dated bonds.
  • One factor behind such low gilt yields is the “credit-crunch” – which, if it continues, poses significant difficulties for mortgage lenders.
  • Mortgages where repayments are linked to consumer or house prices could be attractive and commercially viable.
slide6

Table 6.5. Gilt issuance and gilt yields

Gross (Net)

15

-

year

15

-

year

issuance (£bn)

nominal yield

real yield

2001

02

14 (

5)

4.86%

2.37%

2002

03

26 (9)

4.71%

2.

21%

2003

04

50 (29)

4.70%

2.04%

2004

05

50 (35)

4.57%

1.78%

2005

06

52 (38)

4.24%

1.44%

2006

07

63 (32)

4.41%

1.37%

2007

08

58 (29)

4.

75

%

1.5

0

%

28 Jan 2008

4.5%

1.0%

Notes: 15

-

year real and nominal yields are funding year averages of Bank of England estimated spot yields.

2007

08

estimates are calculated using spot yields up until

11

January 2008.

Sources: Bank of England; Debt Management Office.

slide7

6%

Average long-term real interest rates

5%

Long-term average (1700-2006)

4%

3%

Real yield

2%

1%

0%

1700-

1750-

1800-

1850-

1900-

1960-

1970-

1980-

1990-

2000-

2006

2007

1749

1799

1849

1899

1939

1969

1979

1989

1999

2005

Figure 6.4. Long

term real interest rates on

UK conventional debt

Notes: Nominal 2.5%

consol rate less long

-

term inflation expectations. 1940

59 is omitted from the graph [but not

from the long

-

run average, which otherwise would rise further to just under 3.6%] because rationing during this period

made price data unreliable, leading to a ne

gative real long

-

term interest rate.

Source: Morgan Stanley Research. Estimates of real yields are based on the nominal yield on consols net of a

measure of expected inflation over the coming 10 years. For a detailed description of the method used to const

ruct

the real yields, see D. Miles, M. Baker and V. Pillonca, ‘Where should long

-

term interest rates be today? A 300 year

view’, Morgan Stanley Research, March 2005.

slide10

Table 6.6. Breakdown of gilt issuance by maturity and type

Conventional

Other

%

Total

0

7

7

15

15+

Floating

Undated

Index

-

years

years

years

linked

72.5

2000

01

38.9

16.1

17.4

1.1

1.1

25.3

73.2

2001

02

36.7

17.0

19.5

0.0

1.2

25.6

72.2

2002

03

35.6

17.7

19.0

0.0

1.1

26.7

73.9

2003

04

34.3

18.6

21.0

0.0

1.0

25.1

74.

3

2004

05

37.2

14.1

23.0

0.0

0.8

24.8

73.5

2005

06

32.8

15.4

25.2

0.0

0.7

25.8

72

2006

07

28

19

25

0.0

1

27

74.3

2007

08

17.2

17.1

40.0

0.0

0.0

25.7

Notes: Floating

-

rate gilts have coupons set in line with short

-

term interest rates. The redemption of undated gilts is at

the

discretion of the government.

Source: Debt Management Office.

slide11

Figure 6.9 The Gilt yield curve

6.0

UK 2Y

UK 30Y

5.5

5.0

4.5

4.0

3.5

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

60.0

40.0

UK 30Y-2Y

20.0

0.0

-20.0

-40.0

-60.0

-80.0

-100.0

-120.0

-140.0

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Source Morgan Stanley

slide13

4.5

UK 30Y BEI

4.0

UK 30Y Real Yield

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

Jan-97

Jul-98

Jan-00

Jul-01

Jan-03

Jul-04

Jan-06

Jul-07

Figure 6.10

30-year Index Linked real yield and

Break Even Inflation (BEI)

Source Bloomberg

slide16
The design and funding of mortgages poses several policy issues
  • In the short-term, problems in the wholesale funding markets for lenders are creating strains
  • There is a longer standing set of issues about the types of mortgage lending in the UK
  • The advantages of index-linked mortgages could be substantial
slide17

Table 6.8 Bank Securitisation of Mortgage Loans

Total mortgage loans

outstanding

Securitised

Securitised

2006

(£bn)

(£bn)

(%)

HBOS

219.0

72.7

33

Abbey

101.7

29.1

29

Lloyds TSB

95.3

14.9

16

Northern Rock

77.3

47.2

61

RBS

69.7

15.7

23

Barclay

s

61.7

12.6

20

HSBC

37.4

3.7

10

Alliance & Leicester

38.0

3.4

9

Bradford & Bingley

31.1

6.7

22

Total

731.2

206.0

28

Source: Company data, Morgan Stanley Research