What this chart shows

The chart shows the UK government bond yield curve as at 1st September 2021 (yellow line) and 20th October (blue line). Yield curves compare the yields available on similar bonds with different maturities. The ‘normal’ shape of the yield curve is upward sloping – indicating higher yields on bonds with longer maturities. When the economy is expanding, investors risk a rise in yields as central banks increase interest rates in response to rising inflationary pressures.

Effectively the higher yields compensate investors for tying up their capital for longer, subjecting them to more inflation and interest rate risk. In contrast, an inverted yield curve – where short-term yields exceed longer-term yields – could indicate investor expectations of interest rate cuts as the economy struggles and so they will pay a premium for a bond with a healthy long-term fixed income. This results in long-term government bond prices rising and yields falling, sometimes to below the corresponding yields offered on shorter-dated bonds. Since early September we have seen a significant shift higher in the yield curve. 

Why is this important?

Markets have responded to recent hawkish signals from the Bank of England (BoE) with governor Andrew Bailey stating that the central bank “will have to act” in order to control inflationary pressures, suggesting he believes they might be less transient than first thought several months ago. His comments sparked a sell-off in government debt, sending yields higher and the moves were particularly sharp for shorter maturities - the two-year gilt yield has climbed 0.49% since 1st September.

Recently released CPI for September of 3.1% came in slightly slower than August, but this seems to be a temporary respite as one of the government’s stimulus programmes last year, Eat Out to Help Out, saw prices rise in September 2020 and it now falls out of the year-on-year calculations. Recent fuel, energy and food price increases are yet to enter the calculations either. There are now increasingly higher expectations for action to be taken this year, with the UK likely to become one of the first major central banks to raise interest rates following the pandemic. These potential interest rate rises could pose an additional headwind for consumers and homeowners on top of recent higher energy prices and looming fiscal tightening.

Source: Bloomberg Finance L.P., Momentum Global Investment Management.
Research Date: October 2021