Gilt yields at over 5% may be exciting news for investors, but they reveal some uncomfortable truths about the UK economy.
- A 2-year gilt has just come to the market with the highest yield since 2007
- In the meantime, banks have failed to pass on interest rate rises to savers
- Inflation remains the strongest argument against gilt investment
The UK government has just issued a bond that will pay investors 5.668% over two years. This marks the highest yield of any gilt since 2007 and comes in anticipation of further interest rate rises from the Bank of England.
In the same week, the Chancellor was forced to have stern words with the high street banks, who have so far only passed on a fraction of higher interest rates to savers. Many savings accounts are still paying just 1-2%, even as borrowing rates have soared.
Gilts now appear to be a strong alternative to holding cash. Investors get a high rate of interest and, more importantly, it is guaranteed, rather than being subject to the whims of the high street banks. Investors only have to hold it for two years to achieve a risk-free 5%+. No wonder the most recent auction was 2.7x oversubscribed.
Inflation remains the strongest argument against gilt investment. With CPI inflation running at 8%, investors are still losing money in real terms. Some multi-asset managers have sought to balance their gilt portfolio with the addition of index-linked bonds, which are also at their highest yields in over a decade.
There are greater risks for gilt prices in the secondary market, where interest rate rises could take a toll. That also means investors may have an opportunity to buy in at even higher rates in future. Yields in the gilt market reflect some rise in rates, but no more than another 0.5% or so. The worry would be if inflation proves even more stubborn.
However, while high gilt yields may have appeal for investors, they are more bad news for the UK economy. The government faces its own ‘mortgage crisis’ as its borrowing rolls over and it is forced to borrow at ever higher rates. Fiscal discipline is now more important than ever, but it will constrain investment at a time when the UK economy desperately needs growth.
Equally, it may be another barrier to progress for the lacklustre UK stock market. A 5%+ risk-free return is likely to have more appeal at a time when the economic environment looks increasingly unfriendly. It is another reason for investors to sidestep the UK market, in spite of its undoubted value.
High gilt yields are a great alternative to cash for risk averse investors. However, they signal a wider malaise in the UK economy that is going to be hard to escape.
