Bond Watch: what welfare cuts mean for gilts

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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Spring Statement reassures gilt investors

Chancellor Rachel Reeves announced a series of spending cuts in her Spring Statement this week, in a bid to balance the budget and meet her fiscal rules.

She cut the welfare budget by around £5 billion and announced new tech upgrades to increase tax collection. In total, Deutsche Bank analysts calculate that she could save £10 billion with the changes.

Gilt investors need to assess the creditworthiness of the UK government – if they think that borrowing will have to rise more than expected, they will demand a greater return to lend money to the UK government. This therefore pushes up gilt yields and increases the burden further on the government as its interest bill rises.

Thankfully for Reeves, gilt markets barely moved following her statement. In fact, yields were marginally lower on the day thanks to a lower-than-expected inflation reading for the year to February of 2.8%.

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However, fund managers highlight that Reeves is walking a tightrope between reassuring markets and keeping the economy moving.

Shamil Gohil, fixed income portfolio manager at Fidelity International, says: “The chancellor has replenished the fiscal headroom back to £9.9 billion, which may provide some relief in the short term. But this is a temporary fix, kicking the can down the road. Longer term, budgetary challenges remain as higher interest rates and weaker growth persist.”

He warns that having just £10 billion headroom to meet her rules was “arguably not enough” as the historical average has been closer to £30 billion.

Gohil adds: “A £20 billion number would have been more constructive for gilts. Ultimately, the fiscal headroom is how the market quantifies and judges the chancellor’s credibility. Gilts probably remain in no man’s land until the Autumn Budget as we will likely see some fiscal slippage and buffer erosion from now until then.”

Gilt yields have been rising steadily since February, with the 10-year gilt now offering annualised returns of 4.8%. Longer gilts (those above 15-year maturity timelines) now pay above 5%, while shorter gilts, in anticipation of interest rates falling this year, pay between a little under 4% and 4.4%.

But Jason Borbora-Sheen, multi-asset portfolio manager at Ninety One, says that rising gilt yields are more linked to global markets and economics rather than government policy in the UK.

He says: “Bond markets are most focused on policy from the US (tariffs and the shift from public to private growth drivers) and Europe (defence spending). Gilt yields have been more sensitive to the European fiscal agenda than US policy. These factors dominate domestic developments across regions.”

What this means for gilt investors

Stubbornly high gilt yields mean two things. First, holdings of gilts will have seen the market price of their gilts fall, with longer gilts falling more than shorter gilts. However, holding gilts to maturity means a gradual return to the £100 redemption value of each gilt. So, if you are using gilts as a short-term savings tool, then rising gilt yields is not a problem.

For investors looking at gilts but who have not yet taken the plunge, higher yields mean better returns over the life of the gilt.

For example, the popular UNITED KINGDOM 0.125 31/01/2028 (LSE:TN28) gilt now has a yield to maturity of 3.9% compared with 3.4% in September last year. This gilt costs £89.80 and pays back £100 to the owner on 31 January 2028. This is alongside the annual 12.5p coupon, paid in two instalments.

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Investors must also take into account inflation rates of the life of the gilt. A higher inflation rate, which can be a reason for gilt yields to rise, can lead to a lower “real” investment return.