How gilt yields affect markets and policy

How gilt yields affect markets and policy

The yield on a gilt is inversely related to its price and reflects the market's expectations for interest rates, inflation, and economic growth. When demand for gilts rises, their price goes up and yield falls; when demand drops, the opposite occurs.

Central banks, including the Bank of England, closely monitor gilt yields as indicators of market sentiment. In fact, quantitative easing (QE) programs involve the Bank purchasing gilts to suppress yields and stimulate the economy. This makes the gilt market a central lever in UK monetary policy.

Gilt yields and economic signals

Changes in gilt yields can signal shifts in macroeconomic conditions. For example:

• Falling yields may suggest a weakening economy or increased demand for safe assets.

• Rising yields might indicate expectations of higher inflation or rate hikes.

• Flat or inverted yield curves can hint at recession risks.

• Spread movements between gilts and other bonds can reflect credit risk perceptions.

• Sudden spikes in yields often result from fiscal policy announcements or political instability.

Recent years have seen unprecedented movements in the gilt market, particularly during events like Brexit, COVID-19, and the 2022 mini-budget crisis. Each of these episodes triggered sharp swings in gilt yields, prompting Bank of England interventions to stabilise the market and prevent wider financial contagion.

Because gilts anchor the UK’s interest rate structure, any changes in their pricing ripple across the financial system. From mortgage rates to corporate borrowing costs, gilt yields are baked into virtually every financing decision in the UK economy.

Understanding UK gilts and their purpose

Understanding UK gilts and their purpose

UK gilts are debt securities issued by HM Treasury via the Debt Management Office (DMO) to fund public expenditure. In essence, when investors purchase gilts, they are lending money to the UK government in return for periodic interest payments—known as the coupon—and the eventual repayment of the principal upon maturity.

Gilts are considered among the safest investments in the UK market because they are backed by the government. They are widely used by institutional investors, such as pension funds and insurance companies, due to their stability and predictable income streams.

Types of UK gilts

There are several categories of gilts, each serving a specific purpose:

• Conventional gilts – These have a fixed coupon and a set maturity date.

• Index-linked gilts – These adjust both principal and interest for inflation based on the Retail Prices Index (RPI).

• Green gilts – A newer class that funds environmental and sustainability projects.

• Undated gilts – Rare now, these have no fixed maturity and pay interest indefinitely.

• TIPS equivalents – Though not called such, index-linked gilts are similar to US TIPS in function.

Each type has unique advantages depending on the investor’s objectives and the prevailing economic conditions. For instance, index-linked gilts are favoured in inflationary environments, while conventional gilts are used for predictable income in low-inflation periods.

Gilts are a core component of the UK's financial architecture, directly influencing borrowing costs and monetary policy implementation. They also serve as benchmarks for other interest rates, including corporate bonds and mortgages.