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UK gilts rate forecast: 10-year yield estimates stable around 3.5% as BoE, government tightening reassure markets

By Ryan Hogg

Edited by Jekaterina Drozdovica

14:14, 15 November 2022

Big Ben and the flag of United Kingdom
UK gilts slightly recover after Liz Truss’s failed fiscal policy. – Photo: Tomas Marek

UK gilts are on stable footing again after their most turbulent period in recent memory as political turmoil fed into markets, but a risk premium remains.

What will happen to UK gilts as the government switches off the spending taps, and how will monetary policy affect a UK gilts forecast?

What are UK gilts?

UK gilts are bonds issued by the UK government in order to fund public works and service deficits. They are similar to Treasury bills (T-bills) issued by the US government, and make up the bulk of the country’s debt.

They have a variety of maturities stretching out to 30 years, which in normal times carry progressively higher rates of interest to reflect the burden of holding the debt. 

Because they are backed by the state, UK government gilts are typically regarded as a safe-haven asset, often making up the risk-averse portion of an investment portfolio, as the government is highly unlikely to default on its debt.

UK gilts do carry an interest rate risk, because they can increase in interest after a person begins holding them, raising the yield while diminishing the relative value of their holdings.

Yet how do UK gilts work? The rates on gilts are mainly affected by market risk and interest rate rises, and ultimately adhere to the same supply and demand principles affecting other assets. Demand for gilts rises alongside shocks to higher risk assets like stocks or commodities

Their supply can increase when the government issues more gilts to fund an increase in public spending. These factors can affect the UK gilts outlook.

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UK 10-year gilts performance over past years

Prior to 2022, UK 10-year gilts were decreasing at a steady pace as confidence grew in markets as it battled against a slight rise in its risk premium following the UK’s 2016 vote to leave the European Union. They fell to fresh lows during Covid-19 and the historic bull market that occurred across most assets in financial markets.

UK gilts followed a similar trajectory to other major government bonds in the first half of the year. They began the year at 0.97%, but grew consistently to 2.65% by 21 June as inflation bit into market confidence. 

A surprising drop in the rate of inflation in July pushed UK gilt yields back down, but they soon shot back up amid politically-driven economic turmoil.

UK gilts went as high as 4.5% at the end of September – their highest level since the Great Recession of 2008 - 2009 – on the back of former Prime Minister Lizz Truss’s growth plan which proposed billions of pounds in unfunded tax cuts, shooting up the country’s risk premium.

UK 10-year gilt yields have regulated somewhat in the last month, falling back to 3.4% in mid-November as the government continues to chant its fiscally responsible rhetoric, but remain elevated following trauma of previous announcements and still persistent inflation.

UK government bonds 10-year yield, 2017 - 2022

What's driving UK gilts right now?

Like its Western counterparts, the UK economy is dealing with the highest inflation in decades, which is putting pressure on the central bank.

The consumer prices index (CPI) hit 10.1% in September, up from 9.9% in August as prices continue an upward trajectory that started a year ago as supply chains adjust to Covid-19 and the effects of huge liquidity continue to feed through to markets. 

That was ramped up after Russia’s invasion of Ukraine, bringing with it sanctions and soaring energy prices as oil and gas supplies from Moscow dried up.

These shocks have pushed investors out of risky markets, like the FTSE100 (UK100) which has been volatile this year, and into safe havens like UK gilts. 

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Spread 0.00013

The Bank of England’s (BoE) response has been to instil a strict regimen of interest rate hikes. The Bank Rate has jumped from 0.5% in February 2022 to 3% in November in an attempt to tame price rises. That has added to rising UK gilt yields as investors look for bigger returns to account for rate hikes.

Beyond the macro pressures relevant across the developed world, UK gilt yields are in recovery mode after living through the UK’s most turbulent economic period in recent memory. 

Fiscal policy turmoil

The “Growth Plan” put forward by Liz Truss and her Chancellor Kwasi Kwarteng proposed £45bn in unfunded tax cuts in a massive gamble to stimulate economic growth for the UK economy. The plan included £62.4bn in proposed gilt sales, added to risk premiums and supply which investors were becoming increasingly wary of. The BoE had to step in to protect a meltdown in the pensions market.

Inevitably, financial markets went into meltdown, with the FTSE 100 falling alongside the pound as UK gilt yields jumped. Truss’s resignation quickly followed Kwarteng in the fallout of the disastrous policy.

Now, the Treasury is attempting to cut all its spending under new Chancellor Jeremy Hunt while setting about addressing spending during the Covid-19 pandemic, partly in an attempt to reassure markets and reign in UK gilt prices.

Sources told Bloomberg that Hunt is trying to fill a $35bn fiscal shortfall with spending cuts when he delivers the Autumn Statement on 17 November. The new Chancellor also plans to raise £20bn from tax rises over the coming years to fill a considerable gap in the public finances.

Capital Economics’ chief UK economist Paul Dales said the new government’s step change on fiscal policy would now begin to guide UK gilts. 

“While the risk premium that pushed gilt yields up and the pound down after the mini-budget has mostly been reversed under the stewardship of Sunak and Hunt, the fear that the markets will baulk at any fiscal indiscipline means that the Chancellor will substantially tighten fiscal policy even though the economy is probably already in recession.
“Tighter fiscal policy risks deepening the recession, which we think started in Q3 with a 0.6% q/q decline in real GDP. It might mean, though, that the Bank of England can take its foot off the interest rate brake a bit sooner than otherwise.”

In an October note following Truss’s resignation, ING analysts argued that UK gilt yields would continue to carry a higher risk premium for some time following their September debacle. The analysts wrote:

“Gilts are likely to continue to trade with a sizeable political risk premium for the foreseeable future. At just above 50bp, it is already less than half of what it was in the aftermath of the 'mini' budget, which did so much damage in late September.
“The old adage, that it takes years to build confidence but only one day to destroy it, applies here. At most, 10Y gilts can hope to tighten another 50bp against German Bunds and US Treasuries but the pace of gains is likely to be much slower from now on.”

The disruption under Liz Truss’s government didn’t just hit UK gilt prices, but also filtered through to the country’s currency, which fell to all-time lows against the dollar (GBP/USD) amid the plans for incredibly loose fiscal policy.

GBP/USD live exchange rate

High inflation coupled with a devalued currency increases the burden of debt repayments, pushing UK 10-year gilt yields higher. It’s encouraging then, that the pound has started to rebound since Sunak’s ascendancy. 

Stirling has risen 10% against the dollar since it bottomed out in late September, in a sign of a continued rebound in confidence in the UK economy.

UK gilts forecast for 2023 and beyond

Forecasts generally reflect an expectation that UK gilts will remain elevated for some time. 

In early October Vanguard projected that 10-year annualised returns for UK aggregate bonds have risen from 0.6%-1.6%  to 2.4%-3.4%, while return expectations for global bonds ex-UK (hedged) have increased from 0.5%-1.5% to 2.3%-3.3%3.

A UK gilts forecast from algorithm-based World Government Bonds, as of 15 November, predicted UK 10-year gilts to hit 4.6% by the end of March 2023.

According to a UK gilts rate forecast by Trading Economics at the time of writing, UK gilts were expected to reach 4.2% in 12 months’ time. 

Final thoughts

Note that analysts’ and algorithm-based UK gilts forecasts can be wrong and shouldn’t be used as a substitute for your own research. Always conduct your own due diligence before trading, looking at the latest news and analysis. Note that past performance does not guarantee future returns. And never trade money you cannot afford to lose.

FAQs

Who issues UK gilts?

The UK Treasury issues gilts in order to fund public spending works and its deficit.

Why are UK gilts falling?

UK gilts began to fall after reaching 14-year highs in the wake of reckless spending promises from the previous Lizz Truss-led government.

What happens to gilts when interest rates rise?

Gilts rise with interest rates as investors expect more income from their gilt holdings.

Is it a good time to buy UK gilts?

The decision to buy UK gilts should be based on your risk tolerance, investing goals and overall portfolio needs. Always conduct your own due diligence before buying financial instruments and assets.

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You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
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