Investment Focus: Is now a good time to buy gilts?
Written by Cherry Reynard
29 Aug, 1970
UK gilt yields have hit their highest levels since the financial crisis, pushed up by inflation worries and concerns about government borrowing. That's a headache for the Chancellor – but good news for investors, who can now lock in a real return of 2–2.5%. We explain what's going on, how to buy gilts, and what could happen next.
UK government bonds (‘gilts’) have been gathering a lot of headlines. The interest rate the government needs to pay on its debt has reached new highs as investors have become worried about the outlook for inflation and the government’s financial position. While this may be bad news for Chancellor John Healey as he contemplates his upcoming budget, it may represent an opportunity for investors.
Why have gilt yields risen so sharply in 2026?
Gilt yields have been rising since the onset of the US/Israeli attacks on Iran. In February, the 10-year gilt had dropped to around 4.2%[1] in anticipation of a slew of interest rate cuts. Inflation appeared to be heading in the right direction, while the lacklustre UK economy looked in need of the boost lower interest rates could provide.
The war changed all that. Inflationary pressures re-emerged as energy costs rose. Short-dated bond yield rose rapidly (and bond prices fell), moving from pricing in rate cuts, to pricing in as many as four rate rises within two years. The two-year yield rose from 3.5% to almost 4.8% at its peak [2]. Longer-dated bonds also rose as investors started to worry about the long-term sustainability of UK debt levels. The 10-year peaked at over 5.3%, and the 30-year gilt hit over 5.9%. These are the highest levels since the Financial Crisis.
In early September, the government’s £4.25 billion sale of 30-year gilts came with a yield of 5.82%, the highest for any bond sale since the Debt Management Office’s creation in 1998. This has created some real concerns about the sustainability of government spending and worries over further tax rises in the upcoming budget.
It was also an illustration of the vulnerability of the gilt markets to external shocks. Gilt issuance has ballooned in recent years as the government has shouldered the costs of Covid, Brexit and successive energy price shock. The UK government – in various guises – has failed to take the requisite measures to reduce debt. The UK’s structural debt now sits at £2.93 trillion, and the government continues to spend more than it brings in every year – to the tune of around £120bn in the 12 months to June 2026.
It is worth saying that the UK’s debt levels do not look as bad as some of its peers. Its current debt-to-GDP ratio is 94.9% [3]. That puts it in a better spot than the US (123%), Japan (249%), France (116%) or Canada (114%)[4]. In the G7, only Germany has less debt (63.5%). However, its borrowing costs are still higher than many other countries. This is partly a legacy of the mistrust created by Liz Truss’s mini-budget in 2022, being outside the European Union and the UK’s growing reliance on international buyers to fund its debt.
Will gilt yields remain high?
Domestic UK pension funds, insurance companies and banks have seen their holdings of gilts drop from around 30% to around 20%, while the Bank of England currently holds around 18% of gilts, down from a peak of about 34% in 2022. Overseas buyers now absorb more than 30% of the gilt market, while ‘other financial institutions’ have also become more important buyers [5].
This can create problems. For example, in the immediate aftermath of the Iran crisis, international hedge funds unwinding leveraged positions in gilts created significant disruption. The Bank of England warned of “relatively high use of leverage by a small number of hedge funds pursuing similar strategies across jurisdictions. Such dynamics increase the risk of a disorderly unwind of positions.”
The Bank of England has taken steps to address this problem, paring back its sales of long-dated debt.
The reduction in long end sales will further decrease the pressure on long end gilts, a continuation of the trend started at the last Budget. The coordination of the sales in one place at the Debt Management Office (DMO) should be also applauded. The DMO has shown how receptive it is to market conditions and has guided the gilt market well in recent years. These changes should be seen as gilt positive, in particular for long end maturities.
Nevertheless, it does not shift the fundamentals for the UK debt market. While successive UK governments have stuck to the fiscal rules, and Chancellor John Healey is likely to do the same, spending pressures continue. The Chancellor needs to find money to boost the defence budget and for the various spending commitments made by Prime Minister Andy Burnham since he came to office. Labour backbenchers have shown themselves disinclined to support spending cuts of any kind.
For investors, this means gilt yields are likely to remain high. As recently as 2020, 10-year gilt yields were just 0.2%, meaning investors were losing money in real terms (after inflation). However, investors are now getting a ‘real yield’ of 2-2.5% for investing in UK government bonds. A headache for the UK government is an opportunity for investors.
What are the different ways to invest in gilts?
Investors can buy single gilts when they are issued. This will give them a guaranteed income stream for the duration of the bond, and their money back at the end. These give investors significant control over their expected returns and can be a useful alternative to cash savings for investors willing to lock up their capital for a period of time. Most investment platforms now support the sale of gilts.
Investors can also buy single gilts in the secondary market. There are advantages to buying gilts partway through their term. Not only can investors pick up higher yields at times when markets are nervous, so any profit made when they sell or redeem is also free from Capital Gains Tax. This means they don’t have to be held in an ISA and are a good option for investors that have used up their allowances.
Gilt funds are another option. Fund managers will seek out the parts of the gilt market that appear to offer the best value, based on their analysis of the likely outlook for interest rates, inflation and the UK economy. This has been a difficult approach this year, with the average gilt fund falling 1.2%[6]. It has been a particularly tough year for index tracking funds, which don’t have the agility to move between different parts of the market. It was a similar situation in 2022, when interest rates rose sharply and gilt funds lost an average of 23.9%, but tracker funds were hit hardest.
What is the outlook for gilts?
Whatever investors believe about the direction of the UK economy, interest rates or inflation, there can be little doubt that high gilt yields give investors plenty of margin for error. Gilt yields are at multi-decade highs and are currently anticipating three or even four interest rate rises in the near term. Many economists see this as unlikely. The UK economy is still lacklustre and inflationary pressures have not spread beyond the energy sector.
There is currently little evidence that energy-driven headline price pressures are seeping into core and services inflation prints. The UK labour market has also continued to soften. Nevertheless, the (recent interest rate) decision was finely balanced, with three of the nine members of the rate setting Monetary Policy Committee voting to hike. A rate hike at the next meeting in November is a live possibility. Alongside the decision to hold, the BoE also announced that it would marginally slow the pace of its quantitative tightening programme, slowing sales of its stock of UK government debt. The move saw longer dated UK government borrowing costs pull back from recent highs.
Equally, if there is a shift in the situation in the Middle East, bond yields could drop relatively quickly. Miles Tym, a senior portfolio manager specialising in government bond and macro fixed income mandates at M&G, points out that the recent run-up in yields is only partly about inflation.
It’s a whole host of other factors – ultra-low interest rates have disappeared, central bank support has reversed, some fiscal concerns as well
He says that the debt burden is high and will remain under scrutiny, but the UK is in a better position than many of its peers, with the net deficit slightly falling.
UK fiscal policy is set to tighten a reasonable amount over the next two or three years. This is coming largely from ‘fiscal drag’, whereby thresholds are maintained and more people are dragged into the tax net. As a result, the total tax take as a percentage of GDP is set to rise.
The Bank of England’s reversal of quantitative tightening will also have an impact, with the gilt market needing to find fewer private sector buyers for its debt.
The fiscal position is challenging, but at least we’re doing something about. This compares favourably to other countries where the debt is high and the deficit is high as well and that’s set to continue.
As long as Chancellor Healey doesn’t do anything imprudent at the budget, which seems unlikely, the outlook for gilts is reasonably sound. Certainly, the UK does not appear to be careering towards a debt crisis, as some of the more alarmist commentary might suggest. Gilt yields are high, and pricing in a lot of bad news. This is a chance for investors to pick up a relatively ‘safe’ asset, with a chunky income attached.
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[1] MarketWatch
[2] MarketWatch
[3] Office for National Statistics
[6] Trustnet
