Gilts and yields
What gilts are, why prices and yields move opposite ways and what the curve says
3 min read
Gilts are bonds issued by the UK government. When the government spends more than it raises in tax, it borrows the difference, mostly by selling gilts through the UK Debt Management Office, an executive agency of HM Treasury. Pension funds, insurers, banks, overseas investors and the Bank of England have all been big holders.
- Conventional gilts pay a fixed coupon twice a year and repay £100 for every £100 nominal at maturity
- Index-linked gilts raise their coupons and repayment in line with inflation, measured by RPI
Why gilt yields matter beyond bonds
Because the UK government is seen as very unlikely to default in pounds, gilt yields act as the benchmark for borrowing costs in sterling. Fixed-rate mortgages, company bonds and the discount rates used to value businesses all start from them. When gilt yields rise, borrowing gets dearer across the economy.
Price and yield
A gilt's coupon is fixed when it is issued. If market interest rates rise afterwards, nobody will pay full price for the old, lower coupon, so its price falls until its return matches the market. That is why bond prices and yields always move in opposite directions.
Worked example: current yield
A gilt pays a £4 coupon a year for every £100 nominal. Its price falls to £80.
Current yield = £4 ÷ £80 = 5%
At £100, the same coupon was a 4% yield
Current yield ignores one thing: a buyer at £80 also gains £20 when the gilt repays £100 at maturity. The yield to maturity includes that gain, so it is higher than 5% here.
The yield curve
The yield curve plots yields against how long each gilt has left to run. Its shape is one of the most watched signals in markets.
| Shape | What it looks like | What it often suggests |
|---|---|---|
| Upward sloping | Longer gilts yield more than shorter ones | The usual shape, because investors want extra return for lending for longer |
| Flat | Similar yields at every maturity | Markets expect rates to stay near today's level, or the outlook is shifting |
| Inverted | Shorter gilts yield more than longer ones | Markets expect interest rates to fall, often because they expect the economy to slow |
What moves gilt yields
- Expected Bank Rate: short-dated gilts follow where markets think the MPC is heading
- Inflation expectations: investors want a higher yield if they expect inflation to eat into fixed coupons
- Government borrowing: more gilts to sell, or doubts about the public finances, can push yields up
- Global yields: gilts often move with US Treasuries and German government bonds
- The Bank of England's holdings: selling gilts under quantitative tightening adds to supply
Long-dated gilts are especially sensitive, because a change in yield changes the value of payments that are decades away, so their prices move much more than short-dated gilts for the same change. Pension funds and insurers own a lot of them, since their promises to pay out stretch decades into the future.
How to talk about it
Link a move in yields to a cause and an effect. For example, if ten-year gilt yields rose after a higher inflation figure, that points to fewer rate cuts, dearer fixed-rate mortgages and a higher cost of government borrowing. For duration and breakeven inflation, read Rates, FX and gilts.