There has been a lot of press coverage about the bond markets in the UK and international press, so why is this the case?
Well, yields on some gilts have risen since the beginning of the new year and, in fact, to such an extent that they are at similar levels to 2008 at the height of the financial crisis.
Gilts and Yields
Perhaps it would be helpful to clarify what a ‘gilt’ is. A gilt (gilt-edged) refers to a UK Government liability denominated in sterling, issued by HM Treasury and listed on the London Stock Exchange. It guarantees to pay the holder of the gilt a fixed cash payment (coupon) every six months until the maturity date, at which point the holder receives the final coupon payment and the return of the principal.
The redemption yield, also known as the yield-to-maturity, gives an indication of the actual return on capital that the investor will receive from buying the gilt at the price shown and holding it to maturity. As prices rise the investor is effectively paying more for a series of fixed cash flows and so the yield falls. Conversely, if prices fall the yield rises.
Where we are now?
Rachel Reeves increased borrowing in the last Budget (and gilt issues) to finance increases in spending. Examples include the recent, expensive, public sector pay settlements. Towards the end of last year, there was an expectation that the UK would look to continue interest rate cuts but inflationary pressures and wage growth have tempered this expectation somewhat and so yields on gilts have risen accordingly. As one can see from the previous paragraph, there is an inverse correlation between gilt yields and prices. Further, interest rates for those coming to the end of fixed rates on mortgages are increasing which obviously has an effect on the housing market and spending.
Is this similar to 2022?
The downfall of Liz Truss is synonymous with the spike in gilt yields that caused market consternation after her mini-Budget when she took office.
At the moment, it seems that these current increases are causing concern but not the same level of alarm as in 2022. Despite a slight fall in the value of Sterling, the falls are not on the same scale as before and there does not appear to be any evidence of large institutional cash withdrawals from the UK.
But, Reeves may well have painted herself into a corner. She now has to contend with financing larger government debt (with higher interest payments) which she will not want to increase. This leaves her with a choice of increasing taxes, which have already been increased to the concern of business, or to reduce her spending and possibly break Manifesto promises.
What Next?
Unless Reeves manages to pull a rabbit out of a hat, many think her days as Chancellor may be numbered. It would seem that the increase in taxes will merely be used to finance higher debt costs and be of little benefit to public services, one of the pillars of the UK Governments Manifesto.
UK Pensions
As a final thought, it may be worth considering the effect this will have on those with UK defined benefit (final salary) pensions who may be thinking about a transfer since our firm advises those with British pensions.
Gilt yields have a significant impact on transfer values. When gilt yields rise, the transfer values decreases (making a transfer less attractive), this is because the higher yield means that future pension payment can be discounted at a higher rate- effectively reducing the current capital values of the payment lower. Further, anticipation of higher yields also can depress the value of a transfer.
Of course, the gilt yields and transfer values only form part of the advice whether to stay in a pension with guaranteed payments for life or to transfer. Nevertheless, this is a significant issue to consider.
Questions?
Aisa International stays abreast of political decisions, changing regulations, and their potential impacts on investors. We welcome any questions you may have to keep your savings safe and investments profitable.