On March 26, The Bank of England failed to auction off 1.75 billion pounds of 40-year gilts (the English name for government bonds). This is the first time since 2002 that the Central Bank of England didn’t find enough buyers for its government debt.

Link: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a0UwOQfUC.jw#

So why couldn’t the UK government attract enough bids for the gilts auction? Investors only made bids worth 1.63 billion pounds for the 1.75 billion pounds worth of debt, casting doubts on the UK Central Banks ability to raise debt. One reason is that the yields on these debts have shifted downwards due to the Bank of England’s announcement about quantitative easing.

Quantitative easing is an extreme measure employed by a country’s central bank to increase the money supply when the traditional method of cutting interest rates cannot work because rates are already too low. The Central Bank conducts quantitative easing by purchasing government debt or other securities from commercial banks in exchange for currency that the government prints. Actually, the government doesn’t even need to “print” money in the traditional sense of paper currency since much of the money is handled paperless now with electronic cash.

So this is an interesting dilemma for the UK government. Their recovery strategy is twofold: to increase the money supply so the credit market can start functioning again via quantitative easing and to increase government spending to stimulate the economy financed in the traditional method of raising public debt.

But are these two strategies really compatible? Through quantitative easing, the government increases the money supply through repurchasing government debt with newly created money. This may lead to long-run inflation, making gilts more unattractive to investors because they are making less real return on their investments. This is reflected in the decrease in the yield rate. However, the fiscal strategy of increasing government spending is financed through the auction of government bonds, which are already made unattractive through the quantitative easing program.

In essence, the UK’s Central Bank is the biggest buyer and seller of its own debt. Are the two strategies of quantitative easing and economic stimulus by the UK’s central government contradictory? Should the government decide to either buy gilts or sell gilts, and not both? What impact does the auction failure of government bonds have on foreign investors looking to put money in the UK’s economy?