Bond Watch: UK inflation rises with peak yet to come

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.        

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.             

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Inflation continues to rise  

New figures this week showed that inflation accelerated in January, rising to 3%. This compares with a 2.5% annual rise in December, and was ahead of the expected 2.8% rise in prices.  

Higher private school fees and increased costs of food and non-alcoholic drinks contributed to price pressures.  

Deutsche Bank says that inflation risks may be increasing. The bank says: “We continue to expect a sticky and bumpy path upwards over the next two quarters. While there remains significant uncertainty around the path of energy prices, we see Consumer Prices Index (CPI) reaching a peak of 4.25% over the summer, before making its descent back to target in 2026.” 

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The group expects that tax changes (such as to vehicle excise duty and alcohol duty increases), as well as higher TV licence fees, rail fares, and tuition fees, plus an increased minimum wage, will drive inflation higher.  

Overall, it believes the latest inflation figures lower the chance of back-to-back interest rate cuts. Rates were cut from 4.75% to 4.5% this month, with the next decision due on 20 March.  

Gilt yields have risen this week, suggesting that interest rates could be higher for longer.  

Are bonds a good investment with rising inflation?  

Despite rising inflation, the safest bonds still yield more than the inflation rate: the UK 10-year gilt is at 4.6% and the US 10-year government bond is at 4.5%.  

David Roberts, manager of the Nedgroup Global Strategic Bond, says these starting yields are attractive. 

He points out that G7 country government bond yields are above inflation, as yields have risen recently to price in reinflation risk, meaning that rate cut expectations have been reset and bonds are at a better entry point now. 

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“There could also be capital gains in store if sentiment around inflation reverses,” he adds.  

Bonds therefore offer a good income, alongside the potential for capital gains if interest rates come down faster than expected. 

Fund manager Capital Group thinks that global investment-grade bonds could return 4% a year for the next 20 years. Vanguard believes bonds will return between 4.3% and 5.3% over the next decade.