Are the wheels coming off Rachel Reeves’s ‘wagon’?
Political allegiance may determine your answer to this question, but financial markets are adamant in their opinion.
They believe the wheels are about to spin off their axles with potentially damaging financial consequences for UK households and businesses.
Investors in UK government bonds – both here and from overseas – just don’t believe that the land of milk, honey, growth and prosperity promised by the Chancellor of the Exchequer when Labour stormed into power last summer is deliverable.
All they see is a government that has ramped up state spending through a toxic mix of higher borrowing and vicious taxes on UK businesses. In the process, it has created a poisonous financial recipe that could trigger economic stagnation, possibly recession.
Financial markets are jittery, and the pound is plunging. So, last week, while the Chancellor jetted off to China with a begging bowl and a planeload of City grandees (why, oh why?), UK borrowing costs continued their frightening march upwards.
The yield on ten-year UK gilts (government bonds) – a key measure of government borrowing costs that feeds through to mortgage rates and other loans – rose to 4.8 per cent, its highest level since the 2008 financial crisis.
To put this figure into perspective, it compares to the 4.1 per cent yield on ten-year UK gilts in July last year when Labour triumphed at the polls – and the 4.5 per cent yield in the wake of Kwasi Kwarteng’s tax-cutting Budget in September 2022 that triggered his ‘resignation’ and the end of Liz Truss’s brief reign as prime minister.
Although higher yields make UK gilts more attractive as a potential new component of an investment portfolio – as experts explain later – they are not good news for a government dependent upon borrowing for its grand economic revival plan to work. Rising gilt yields mean higher borrowing costs for the Government – and given the strict fiscal rules Ms Reeves imposed on the public finances in last October’s Budget, she is becoming increasingly boxed in.
If these debt costs keep rising, she will have no choice but to either curb government spending (fat chance) or, God forbid, fleece taxpayers and businesses with even more tax rises.
If the latter option is chosen – so far, the Government has indicated further tax rises are not on Ms Reeves’ to do list – it will trigger a spiral towards economic calamity. Ben Kumar, head of equity strategy at investment house 7IM, says: ‘Sentiment about the UK has been hurt by the fear that the economy may be entering a period of stagflation – little growth but persistent inflation.
‘Combined with a 2024 Budget that ushered in more borrowing, and the current uncertainty worldwide over the inflationary impact of the tariffs threatened by Donald Trump, investors are asking for a little more return [interest] in order to lend to the UK.’
David Coombs, head of multi-asset investment at Rathbones Asset Management, believes higher gilt yields are not just a headache for the Chancellor. They are also detrimental to both businesses and households. He explains: ‘They push up mortgage costs and other domestic loan rates. This has a negative impact on consumer spending and could tip the UK economy into recession.’
As for businesses, Coombs says that higher gilt yields are particularly negative for companies with lots of debt. ‘Corporate loans tend to be charged at a premium over government bond yields,’ he adds.
‘So as gilt yields push upwards, their cost increases and profit margins reduce – at a time when companies are already dealing with higher wages and taxes post Budget.’
SO, WHAT DO YOU NEED TO DO AS AN INVESTOR?
Below, Money Editor Rachel Rickard Straus explains what higher gilt yields and a weaker pound mean for key aspects of your household finances.
As Rachel says, it’s not all bad news, especially on the cash-savings front and for those looking to turn a pension fund into a stream of lifetime income through the purchase of an annuity.
Better deals for both are likely if gilt yields stay where they are – or edge higher.
For example, savings bank Aldermore has already tickled up rates for those taking out new fixed rate savings bonds.
For those managing an investment portfolio – either ahead of (or in) retirement – the current financial market hiatus is also not a one-way ‘bad news’ ticket.
While experts are divided about the outlook for UK equities, they are unanimous about the attraction of locking into attractive UK gilt yields. Kumar of 7IM says: ‘Rising government bond yields may be a thumping headache for Labour, but they provide a great chance for investors to lock into some chunky returns.
‘As long as you think the UK government is going to pay you back when the bond matures, current high yields can represent quite an investment opportunity.’
It is a view shared by Bryn Jones, manager of £2 billion fund Rathbone Ethical Bond. He says the case for having a ‘decent slug’ of UK gilts in your portfolio, providing a return in excess of current inflation, is compelling.
He adds: ‘If you can buy into a UK gilt providing a risk-free annual return of between 4 and 5 per cent, even a poker player would think it’s a better alternative than the stock market, which, on average, will give you an annual return of between 6 and 7 per cent. The potentially extra juice that an investor can extract from equities begins to look less attractive.’
HOW YOU CAN OBTAIN A GOOD BOND RETURN
UK gilts can be bought through all investing platforms, albeit subject to a dealing charge and an annual fee. For example, those using an AJ Bell standard dealing account pay £5 per gilt trade plus an annual 0.25 per cent charge (capped at £3.50 a month).
Income from a UK gilt is taxed, but there is no capital gains tax on gains made from price movements. If held inside an Individual Savings Account (Isa) or a self-invested personal pension (Sipp), the income – often referred to as the ‘coupon’ – is tax-free.
Last week, Laith Khalaf, head of investment analysis at AJ Bell, provided Wealth with illustrations of some of the returns on offer. They are not, he stresses, recommendations while gilt prices (like shares) change minute by minute, impacting on the return an investor can lock into.
He adds: ‘Investors need to do their maths when they trade, which makes buying gilts for more experienced investors with a head for numbers.’
Take 0.125 per cent Treasury Gilt 2026. As its title indicates, it pays investors a coupon (income) of 0.125 per cent, with the bond maturing at the end of January 2026. Last Wednesday, the gilt was trading at 96p, compared to a maturity price of £1 (standard for all UK gilts).
This meant an investor could buy the gilt assured of a tax-free capital gain of 4.17 per cent provided they held it until maturity. On top, they would receive 0.13 per cent annual income – taxable if not held inside an Isa or Sipp. So, a total annual return of 4.3 per cent.
Assuming the gilt was not held inside an Isa or Sipp, it is a better option than having money in a savings account (because most of the return is from the capital gain, not the coupon).
For example, a higher rate taxpayer who has exhausted their £500 annual tax-free personal savings allowance – so is taxed on the interest from the bond – would receive an annual post tax return of 4.24 per cent. To get this from a savings account, they would need to find one with a gross interest rate of 7.07 per cent. Impossible – and if you find one, it’s a scam.
Khalaf did the same calculation for 0.5 per cent Treasury Gilt 2029. Last Wednesday it was priced at 85.71p.
Buying it then would have assured an annual capital and income return of 3.93 and 0.58 per cent respectively – 4.51 per cent in total – provided the bond was then held until maturity in just over four years’ time (January 31, 2029). For the same higher-rate taxpayer, the annual post-tax return would be 4.28 per cent, which as a saver they could only match if an account was paying 7.13 per cent.
For those who are comfortable with holding individual UK gilts – and like their numbers – website yieldgimp.com provides information galore on the returns investors can earn from holding specific UK gilts until they mature (note: I found it somewhat overwhelming).
GOVERNMENT BONDS WITH AN OVERSEAS MIX
Some investors may prefer to obtain their UK gilt exposure through a bond fund that invests across a range of individual bonds.
Funds worth considering include Amundi UK Government Bond (annual fee 0.05 per cent), iShares Core UK Gilts (0.07 per cent) and Vanguard UK Government Index (0.12 per cent). Other funds – for example, Rathbone Ethical Bond and Artemis Strategic Bond – invest in a mix of government and corporate bonds (UK and overseas).
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DIVERSIFY WITH A BROAD CHURCH OF EQUITIES
For all the current opportunities from UK gilts, investors need to keep their wealth portfolios diversified across all assets.
That means holding a broad church of equities – shares and funds, both UK and overseas and assets such as gold or funds that track the gold price. Online bullion trader BullionVault says 30 per cent of its clients hold gold as a portfolio diversifier.
And, of course, multi-asset portfolios (the kind run by Coombs at Rathbones) that provide diversification under one roof.
For example, while Coombs has been busy reducing exposure to UK stocks in the £3.3 billion Rathbone Strategic Growth fund, its biggest asset class remains equities. Oh, and don’t forget good old cash.
What to do NOW to safeguard your mortgage, holiday cash and savings
MORTGAGES
Swap rates, which are used by lenders to price their mortgage deals, inched up following the bond market turmoil. However, that has not yet translated into higher mortgage rates.
David Hollingworth, associate director at broker L&C Mortgages, says: ‘Some have shifted up, some down, but we’re not yet seeing panicked lenders rushing to remove deals or reprice them upwards.
‘We’re watching closely to see if this changes.
‘Lenders price their deals as tightly as they can because it’s a competitive market, so they have less margin to absorb rate fluctuations.
‘If rates start to rise it tends to be the more specialist lenders that move first, followed by the mainstream ones.’
Hollingworth suggests that borrowers whose current mortgage deal expires within the next six months should lock in a new one now.
Then, if rates do rise over the coming weeks, they have secured the best deal they can. If rates fall, they can ditch it and find an even better one.
HOLIDAY CASH
The pound fell by over 1 per cent against both the US dollar and the euro last week.
Lee Hardman, a senior currency analyst at financial group MUFG, says that if the bond market mayhem continues there is a risk that the pound will weaken further – especially against the dollar.
However, he suggests anyone planning to visit the US this summer should hold off from buying holiday money now.
‘You may want to wait until closer to the summer, as by then hopefully the pound will have regained some strength,’ he says. ‘The dollar rose by around 5 per cent after Trump’s election, on the basis that his policies would be positive for the US dollar. That has been priced in already.
‘We think that as we move through the year we will see the strength reverse, as a result of some disappointment that all these policies may not be realised. Plus, Trump is likely to want a weaker dollar to support manufacturing, so he is likely to push back if it gets too high.’
But for holidaymakers going to Europe in the summer, he suggests they may want to buy some euros now.
That is because the pound does not look weak against the euro even following last week’s drop in value, so is less likely to strengthen over the coming months.
ANNUITIES
Those looking to lock in their retirement income may be able to secure the best deal since 2008.
An annuity allows you to swap a pension lump sum earned throughout your working life for a guaranteed annual income – either for a set period or until you die.
Annuity providers buy long-term gilts – bonds issued by
the Government – to generate returns to pay customers the income that they have promised. When yields on those gilts rise, so does the income that annuity providers can offer.
As a result, annuity rates have risen by 70 per cent since their low in 2020, according to William Burrows, who runs The Annuity Project and is a financial adviser at Eadon & Co.
Someone buying an annuity for £100,000 at the age of 65 today could secure an income of £6,465.
This assumes that it pays out the same sum every year, and continues to offer two-thirds of the income to a spouse who is five years younger when the annuity holder dies. The same annuity taken out in 2020 would have paid out just £3,800.
SAVINGS
Savings rates did not react to last week’s turbulence in the bond markets.
However, some table-topping deals were launched, such as a cash Isa from Plum which pays 5.01 per cent, paid monthly. The rate drops if you make more than three withdrawals.
However, Rachel Springall at rates scrutineer MoneyfactsCompare suggests that if there are murmurings that interest rates will not drop as soon as previously expected, that will be a good thing for savers.
‘The next base-rate decision is in February, but we have the latest inflation figures before that, which will give us a better indication of where things are heading,’ she says.
