Government unveils steps to repay £2 billion WW1 debt

You may not know this, but 100 years after the First World War began British taxpayers are still servicing the loans taken out to finance it.

This morning the Treasury has announced that it will pay off £218 million of war debt and is "examining the practicalities" of redeeming the £2 billion pounds of war bonds that will remain outstanding.

This is interesting in so many ways. First, the backstory:

When conflict broke out in 1914 imperial Britain was the world's economic powerhouse, but the length and scale of WW1 was such that Britain had to borrow money to pay for it.

The British public found themselves paying more in tax to fund the war effort, the Government also appealed to the public to dip into their saving and buy what became known as "War Bonds".

Don't be put off by the jargon. A "bond" is simply a type of loan. In return for cash the borrower (in this case the British Government) promises a fixed rate of interest for a specific period, after which the original sum borrowed is repaid.

Around three million people bought War Bonds. At the time they were sold using the slogan "unlike the soldier, the investor runs no risk".

That turned out not quite to be true. The interest rate on WW1 bonds was initially 5%, it was slashed to 3.5% in 1932 by Neville Chamberlain when Britain found itself in financial difficulty (a technical default, some would argue).

Chamberlain also converted the bonds into "perpetuals", in effect giving the Government the right never to repay the original loan as long as they continue to pay the interest.

So why is the Government looking at paying it back now? This is the other interesting element of this story.

This is not simply an act of nostalgia in the run up to Armistice Day, Britain's borrowing costs in recent years have fallen to such a low level that it makes financial sense for the Government to take out new loans to repay old debt.

The British Government can borrow over a 20-year period today at close to 3% interest.

The Government will tell you this is because it is managing the nation's finances so magnificently, but it's mainly thanks to the Bank of England.

Interest rates remain at record low levels and in the last five years the Bank of England has been furiously creating new money and using it to buy UK government bonds (quantitative easing), creating a market for our national debt which wouldn't otherwise exist.

The savings here are not enormous, but every little counts.

In February, the Government will redeem the War Bonds that Churchill refinanced in 1927 (coupon rate 4%) including First World War loans and some which date back Napoleonic and Crimean Wars.

£218 million will be refinanced, probably saving the taxpayer something in the region of £2 million a year in interest.

That will leave £1.938 billion outstanding. At current rates redeeming these War Bonds could save the taxpayer around £60 million.

In value terms the bulk of Britain's First World War bonds are held by big City institutions, but over 100,000 War Bonds are worth less than £1,000 and are held by ordinary members of the public.

In many cases these bonds will have been passed down through the generations.

Their value has been slowly eroded by inflation (£100 in 1914 is worth around £3,000 now) and the returns today are almost derisory (a War Bond of £100 pays out £3.50 in annual interest). But I imagine the sentimental value is immense.

It's possible, I suppose, that any plan to redeem the rest of Britain's war debt would meet resistance.

There are some willing sellers. I've just heard back, incidentally, from Threadneedle Asset Management, the City fund manager which claims to be the second-biggest holder of Britain's First World War bonds.

Toby Nangle, co-head of asset allocation, calls the Treasury's decision "a great example of pragmatic and attentive debt management on the part of the UK Government."

"I hope that this move is the first of many to cut the interest bill and save taxpayers money," he added.

One final thought, If your mortgage was fixed at 3.5% in perpetuity would you refinance?

If War Bonds are repaid, the Government surely betting against big interest rate rises.