Key Takeaways
- Gilt yields have surged this year amid political uncertainty and higher inflation expectations following the Iran war.
- Despite stabilizing in recent weeks, yields are still the highest among the G7 nations.
- Fund managers say current yields are attractive, but the Autumn Budget is a key test of the Burnham government’s commitment to fiscal discipline.
Political turmoil and worries about the fiscal outlook have the UK government bond market offering the highest yields among major developed economies. Fund managers say those yields look attractive, but the lofty income comes with clear risks.
One key risk is the inflationary impact of the Iran war, and whether this will push the Bank of England to raise interest rates this year, which in turn could send bond prices lower and yields still higher. At the same time, while the new prime minister and chancellor have committed to the current “fiscal rules,” the Autumn Budget on Oct. 28 will reveal whether the government plans to fund its long-term social programs via more borrowing or higher taxes, which could also push yields higher.
Against this backdrop, yields on 10-year gilts are close to around 5%, 0.5 percentage points higher than the start of the year. For 30-year gilts, yields are roughly 5.75%, a level last seen in 1988. The yield on the 30-year started the year at 5.25%. And two-year gilt yields rose nearly 1 percentage point in March to 4.6% as investors priced for the likelihood of interest rate hikes, rather than the cuts expected before the outbreak of the Iran war.
UK Political Risk Reflected in Bond Markets
Keir Starmer’s exit from Downing Street in July added to bond volatility, as uncertainty around the future of former chancellor Rachel Reeves’ fiscal rules unnerved fixed-income markets. Global forces also had an impact, with longer-dated bond yields rising across the developed world over concerns about government debt levels.
The long-term policy uncertainty is the main reason Kostas Deslis, portfolio manager at Neuberger, is cautious about longer-dated bonds like the 30-year gilt, despite yields nearing 6% amid depressed prices. “Higher spending means higher gilt issuance, and that supply lands disproportionately at long maturities,” he says.
Al Cattermole, a senior fixed-income portfolio manager at Mirabaud Asset Management, says gilts are attractive, but the Iran war’s impact on inflation and the credibility of the Burnham government’s spending plans remain key risks. He says Chancellor John Healey’s inaugural Autumn Budget on Oct. 28 will be a major test as the Burnham government sets its spending plans.
But Nicolo Bragazza, portfolio manager at Morningstar Wealth, says some of the risks of unsustainable government spending, as reflected in higher bond yields, are being overblown: “I think the market has gotten ahead of itself, especially when it comes to fiscal risk, and therefore we expect to get some nice returns out of the historically high yields from the UK over the coming years.”
