U.K. Prime Minister David Cameron has made credibility with bond investors the linchpin of his deficit-reduction policy. In France, Socialist President Francois Hollande has called financial markets his enemy.
With all that, bond investors are tilting toward France.
The premium investors demand to hold French 10-year government debt instead of same-maturity gilts has narrowed to 8 basis points from 26 basis points at the end of March and almost a percentage point from a year ago. The cost of insuring French sovereign debt against default has fallen 16 percent this year, the fourth-best performer in Europe, credit-default swaps show. It has climbed 15 percent for the U.K., the third worst.
While both leaders are struggling with mounting debt and sputtering economies, Hollande says his resistance to the kind of austerity that Cameron’s Conservative-led government is pursuing has sheltered France from a deeper recession. Their divergent paths highlight a wider debate over whether axing budgets is the recipe for recovery or recession as the world faces another slowdown.
“The U.K. does have more pro-business policies but they have yet to get that growth,” Pierre-Olivier Beffy, chief economist at Exane BNP Paribas in London, said in an interview yesterday. “France has a smaller hole to dig itself out of.”
French debt rose today, with the 10-year yield declining 1 basis point to 1.74 percent at 8:35 a.m. in London, while 10- year gilt yields were little changed at 1.66 percent.
Cameron has sought to lure busineses from abroad with the promise of lower taxes. After Hollande came to power last May on a campaign to tax million-euro ($1.3 million) incomes at a rate of 75 percent, Cameron offered to “roll out the red carpet” to French taxpayers and companies seeking to quit the country.
Hollande is seeking to reconfigure the tax after it was struck down by France’s highest court as unfair. In Britain, the top rate of tax, levied on personal incomes over 150,000 pounds a year, fell to 45 percent from 50 percent this month and Cameron has pledged to cut the tax rate on company profits to 20 percent in April 2015, the lowest among Group of Seven countries. The government has lowered the rate to 23 percent from 28 percent since taking office in May 2010.
Still, the U.K. economy is struggling to avoid a third recession and Britain lags behind France in the fight to recover output lost since the collapse of Lehman Brothers Holdings Inc. almost five years ago. In the fourth quarter, gross domestic product was 2.9 percent below its peak in early 2008, while French output was only 1.1 percent lower, government data show.
The U.K. budget deficit is almost twice as big as France’s. The shortfall is forecast to reach 7 percent of GDP this year, compared with 3.7 percent in France, according to the International Monetary Fund. The two countries are forecast to have similar government debt burdens this year: 92.7 percent of GDP in France compared with 93.6 percent for the U.K., the IMF estimates.
With the IMF trimming its global growth forecast on April 16 and economic data from the U.S. to Europe undershooting estimates, the debate over budget cutting is being re-aired with the fund and the U.S. questioning austerity-first policies in Britain and the euro area.
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., told the Financial Times in an interview published yesterday that Britain and much of Europe are wrong to pursue austerity and that to generate growth “you’ve got to spend money.”
For Cameron, who faces an election in 2015, the challenge is to bolster growth without denting investor confidence in the government’s ability to reduce its budget shortfall. The benchmark 10-year gilt yield was 1.65 percent yesterday, compared with 3.9 percent when the government came to power.
The U.K.’s shrinking “fiscal space to absorb” economic shocks was cited by Fitch Ratings when on April 19 it became the second ratings company to strip Britain of its top rating. Moody’s Investors Service was first, downgrading the nation on Feb. 22.
As part of Europe’s 17-nation single currency, France’s benchmark interest rate is set at the European Central Bank in Frankfurt. European treaties prevent the central bank from financing governments, contributing to a four-year-old sovereign debt crisis that has slowed growth across the region.
In the U.K., as Cameron drives through the deepest budget cuts since World War II, the Bank of England has helped support the economy by buying 375 billion pounds ($575 billion) of gilts.
“The biggest difference between the U.K and France is that the U.K. has a much more accommodative monetary policy,” Beffy said. “The result is that in France the risks are skewed to deflation while in the U.K. they’re about inflation,” he said.
The U.K. 10-year breakeven rate, a gauge of expectations of inflation derived from the difference in yield between regular and index-linked bonds, was at 3.15 percentage points yesterday, the highest in the Group of Seven, data compiled by Bloomberg show. For France, the breakeven rate was 1.78 percent.
Two decades after Cameron’s predecessor Margaret Thatcher fought to keep the U.K. from joining the European currency, the two countries remain as divided as ever over economic policy even if their governments face similar struggles in reviving growth.
“The policy I’m carrying out is that of reviving the country’s financial and productive potential,” Hollande said April 10. “This is to combat unemployment. I’ve put in place serious budget discipline. That’s not austerity.”
Compare that with Cameron, who last month chastised his Liberal Democrat coalition partners calling for more spending as talking as if “there’s some magic money tree.”
Cameron’s own lawmakers are pressing him to hold that line. Brooks Newmark, a Conservative member of Parliament’s Treasury Committee, said the fact that U.K. unemployment is 7.9 percent compared with 10.6 percent in France shows Britain is following the right policies. Gilts handed investors 1.78 percent this year, outperforming the 1.06 percent return on French government debt, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.
“I’m not going to buy into the narrative that France is in better shape than the U.K.,” Newmark said in a phone interview on April 19. “I’m looking at our employment figures, our interest rates, our austerity program, which is the right thing to do, and the French program, which is the wrong thing to do.”
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