The sharp drop in government bond yields in recent weeks could save the Exchequer around €16-€17 million in interest payments this year.
The threat of war over Iraq, weak equity markets and the slow economic recovery have pushed US Treasury yields to their lowest levels since the 1960s while government bond yields in the eurozone are near historic lows.
The fall in yields brings some small measure of good news for the Government, forced to tap the international debt markets again this year after a number of years when large surpluses meant it did not have to borrow at all.
The downward trend in yields, which has seen the Irish 10-year bond yield fall to around 4.7 per cent from 5.4 per cent in May, makes it cheaper for the Exchequer to borrow. Provided yields remain at these levels over the balance of the year, savings of the order of €17 million are expected. If yields were to remain at or around current levels into next year, it would result in an even greater saving of some €30 million.
The National Treasury Management Agency (NTMA), which manages the national debt, is expected to raise nearly €6.5 billion this year. It holds its next monthly auction on Thursday when it will sell €600 million of 10-year bonds.
The NTMA has had little trouble finding a home for its bonds since its return to the international debt markets earlier this year. Most are sold to to investors in the euro zone, particularly in Germany, but also in markets like France and the Netherlands.
In 1999, just 21 per cent of Irish government bonds were held by non-resident investors but that figure has risen to 61 per cent by the end of March.
However, the sharp drop in global bond yields has raised broader concerns that this "flight to quality" could push the global economy into a Japanese-style slide towards deflation.
Government bond yields are regarded as the best indicator of inflation expectations, because they offer investors a measure of what today's money will be worth in five or 10 years.
Yields have been declining steadily since September 1981, when the 10-year Treasury briefly rose above 15 per cent.
Many strategists believed a trough had been reached in the aftermath of September 11th, when yields dipped to 4.5 per cent before rebounding as the US economy seemed set for recovery. But the 10-year Treasury note yield recently fell below 4 per cent for the first time since June 1963. It did so again in New York trading last week, as equity markets lost ground both in the US and in Europe.
Usually, as bond yields fall, so do interest rates and therefore the cost of borrowing, which should stimulate economic growth and, eventually, higher interest rates and a rise in bond yields.
So far, however, this has not happened, leading some to ask whether the markets now expect a completely different economic environment - one of sustained low inflation, low interest rates and low government bond yields. "We are looking at a deflating asset price bubble on a global scale," says Mr George Cooper, global fixed-income strategist at Deutsche Bank.
"Added to that, Japan is already deep in deflation and since China joined the World Trade Organisation, it has been increasingly exporting disinflation by producing low-cost goods. In Europe, the single currency was introduced in part to control inflation. And now, in the world's largest economy - the US - the faltering economy and the debt mountain mean pricing power is unlikely to recover."
If deflation is coming, US and European government bond yields still have a long way to fall. The bursting of the Japanese bubble in the early 1990s pushed government bond yields close to 1 per cent as investors piled into bonds and cash. - (Additional reporting, Financial Times Service)
