The consequences of rising UK Gilt yields on fiscal policy,pensions and mortgages

Today I wish to cover several trends of these times as they have all come together in one market. That is the UK Gilt market which is the name for UK government bonds. This is currently being influenced by quite a few factors at once but let me open with the two main factors which brought it to extraordinarily high levels in price terms and low levels in yield terms. The first is illustrated by this from Kenneth Rogoff in the Financial Times.

The mixed results from experiments with negative interest rate policy in Europe and Japan have led many to conclude that the idea is ill begotten and should be abandoned. To do so would be a serious mistake.

As you can see given a choice between reality and the view inside his Ivory Tower he much prefers the latter. This establishment view has driven interest-rates and bond yields lower around much of the world. Added to this in the UK has come the extra £60 billion of QE (Quantitative Easing) purchases of UK Gilts announced by the Bank of England in early August. Today will see it attempt to buy some £1.17 billion of long and ultra long UK Gilts as it buys ones maturing between 2032 and 2068.

A Reversal In Yields

Back in the 12 th of September I pointed out that the benchmark UK ten-year Gilt had a yield which had risen from the 0.5% it had fallen to up to 0.88%. This week it has pushed back up above 1% (1.01%  as I type this) which meant that yesterday the Bank of England found itself buying some of our 2023 Gilt at a yield some 0.25% higher than the week before. That is a lot on a yield which was 0.38%! I will be checking later what they pay for our longest dated Gilt and how that compares to the 198 they have paid to get a scale of a program which in its recent incarnation is running at a marked to market loss.

If we look for the yield most relevant to fiscal policy the thirty-year has risen to 1.7% (low 1.19%) and for fixed-rate mortgages the five-year has risen to 0.4% from a low of 0.12%.

What has caused this?


Markets seem to have suddenly realised that inflation is going to go higher as this from the Financial Times indicates.

As a result, market expectations of UK inflation measured by the five-year break-even swap rate have jumped to 3.6 per cent — the highest level since early 2013.

Regular readers will be aware that I was expecting a rise in UK inflation as 2016 heads to a close anyway and it would have been enough to make even the new five-year yield look silly in real terms. It would also question the ten and thirty year yields. Now if we add to this the extra 1.5% of annual inflation I expect as the impact of the lower UK Pound £ then even the new higher yields look rather crackpot. Over as far ahead as we can see then we are expecting inflation adjusted or real yields to be strongly negative. Accordingly the UK Gilt market has been singing along to the Nutty Boys.

Madness, madness, they call it madness
Madness, madness, they call it madness
I’m about to explain
A-That someone is losing their brain

Why have they done this? This is another theme of these times as they are simply front-running the Monday, Tuesday and Wednesday purchases of the Bank of England. This manipulation of the market by it means that all the old rules for pricing Gilts have been both broken and ignore or if we are less polite a false market has been created.

Fiscal Policy

The impression that the UK government will loosen fiscal policy has gained ground and this has two components. The first is that it seems likely to spend more than the previous administration in a like for like comparison and secondly there is the impact of releases like this from the UK Treasury. This has had an impact today although it is in fact the same one released several months ago.

Cabinet ministers are being warned that the Treasury could lose up to £66 billion a year in tax revenues under a “hard Brexit”, according to leaked government papers.

GDP could fall by as much as 9.5 per cent if Britain leaves the single market and has to rely on World Trade Organisation rules for trading with the continent, compared with if it stayed within the EU, the forecasts show.

So those with short memories will be made nervous by the “scoop” in the Times. I do not know if the expected 18% fall in house prices is still in it as well.

The wider picture

We are seeing a global move towards higher yields and as an example we even now have a positive yield for ten-year German bunds albeit one of a mere 0.06%. The US 10 year Treasury yield has risen to 1.76% on the back of stories like this from Bloomberg.

Pacific Investment Management Co. says the Federal Reserve may raise interest rates two or three times by the end of 2017. Treasuries tumbled after oil prices rose.

Are those the ones that have not taken place so far in 2016? Also it is hard not to have a wry smile at the statement by Pimco that UK Gilts were on a “bed of nitroglycerine” which preceded one of the strongest rallies in history.

Not everybody is upset by this

If we move to the world of pension deficits then quite a few UK companies may welcome higher Gilt yields. This has been illustrated by this news today from Pensions World.

The aggregate deficit of the 5,945 schemes in the Pension Protection Fund (PPF) 7800 Index has decreased to £419.7bn at the end of September 2016, from a deficit of £459.4bn at the end of August 2016.

So £40 billion less to find which even in these inflated times is still a tidy sum. For those of you who would like to know the total sums at play, here they are.

Total assets were £1,449.5bn and total liabilities were £1,869.3bn. There were 4,993 schemes in deficit and 952 schemes in surplus.


Let us take a dose of perspective. If I look back over my career I can recall longer Gilt yields being 15% and more so 1.7% remains extraordinarily low and we should take advantage of it if only to improve the cost of our stock of Gilts. On that basis the recent rise is small but it also shows that we should not dilly and dally forever as events move on.

However there is another case of a false market here and it is one created in inflation-linked Gilts. They should be rising as inflation forecasts rise but whilst they are not part of the QE program their price has been driven higher by it as they are closely linked to ordinary or conventional Gilts. So we face the prospect of another false market as it is possible that higher inflation could be accompanied by lower prices for index-linked Gilts. Mind you I see that the new boy at the Bank of England is getting in his excuses early. From @LiveSquawk.

BoE’s Saunders: Expects MPC To Tolerate Modest Currency-Driven Inflation Overshoot In Next 2-3 Years

I wonder what “modest” is?

BoE’s Saunders: Expects GBP Weakness To Lift Inflation ‘Quite Substantially’

Oh and we see a clear sign of one of Carney’s cronies as we see a breathtaking attempt to shift the blame for the consequences of QE.

Saunders: Government Has Many More Tools To Resolve Distributional Effects Of Monetary Policy Than BoE





18 thoughts on “The consequences of rising UK Gilt yields on fiscal policy,pensions and mortgages

    • Anything over 3% starts to get interesting as Gilt redemptions in 2017 have an average nominal yield of 2.5% and in 2018 they have an average of 3.2% (source the DMO),. Once the DMO has to start paying more interest to roll over redeemed GIlts, then it was paying on the redeemed bonds; we will have austerity for real as the governments fiscal position becomes unsustainable very quickly as yields increase towards historically normal levels.

  1. Is the now crumpled piece of aluminium (which once resembled a can) finally reaching the end of the road?
    I wonder how far the BoE dare let inflation go before they are forced into killing our debt fuelled economy ?

    (Forbin, sorry but I’m long sick of the taste of popcorn) 😉

    • Hi Tim

      If the testimony of the new boy Michael Saunders is anything to go by they are already preparing the excuses for above target inflation. They will try to avoid mentioning that not only did the Bank of England ease policy it then promised more of it! Yet another Forward Guidance disaster.

  2. Great blog, Shaun, as always.
    Michael Saunders came to the defence of the dysfunctional recommendations of the Johnson Report on consumer price indices when it emerged. The Wall Street Journal wrote: “For one thing, even if the government instructed the BOE to target CPIH instead of CPI, assuming CPIH’s problems can be fixed, it would be unlikely to mean a big change in monetary policy as the two indexes track each other pretty closely, said Michael Saunders, an economist at Citi.” True, of course, but only because CPIH uses rents to proxy homeownership costs, and so excludes house prices. I suppose this stout defence of the Johnson Report is one of the reasons he is now an external member of the MPC.
    I noticed that when Saunders was appointed to the MPC in April, FT quoted him as saying: “The next move in rates will eventually be up rather than down, in both a Brexit scenario and our base case of continued EU membership.” He’s obviously not Nostradamus.

    • Hi Andrew and thanks

      As to the inflation targeting regime this is in fact a confession that CPIH is a waste of time.

      “For one thing, even if the government instructed the BOE to target CPIH instead of CPI, assuming CPIH’s problems can be fixed, it would be unlikely to mean a big change in monetary policy as the two indexes track each other pretty closely”

      The whole point of CPIH is to provide more information and in particular about the housing market. If it provides little or nothing why bother? Except of course to claim you are doing something.

      Good spot about Michael Saunders pre Brexit by the way….

  3. Is there a distinction to be made between a rise in yields and a rise in Bank Rate?

    The rise in yields for gilts is the obverse of the fall in price so this is bound to affect both interest on the national debt and therefore fiscal policy and also pensions which are based on gilt yields.

    But I would have thought mortgages would be more affected by the administered Bank Rate via tracker rate arrangements and many are now on fixed rate deals anyway.

    As to how high inflation could go without a response from the BOE I think the answer is clear: very! Almost any increase in rates might pop the bubbles and once this starts there’s no end and I believe the BOE knows this full well and will only increase rates if absolutely forced to because they know it will bring down the whole house of cards. They will not precipitate a crash they will wait for it and then say that they could never see it coming but that unfortunately people must now be prepared to make sacrifices in these new conditions……

    • I read a report on the current Sterling trade which described it as a ‘panicked frenzy’ which does nicely sum it up. There really is no need for the enormous drop in the pound when Brexit hasn’t yet happened, the markets have no idea what policy will be followed or how the EU will actually react. This is simply the FX gambling herd getting their retaliation in first. If it continues, we may yet see the BofE forced to increase rates to defend the pound as there is a limit as to how much depreciation is good for the economy and good for the governments popularity.

      • Pavlaki: If it continues, we may yet see the BofE forced to increase rates to defend the pound as there is a limit as to how much depreciation is good for the economy and good for the governments popularity.

        Oh, please, please, please, please, PLEASE!!!
        It’s the nearest I’ll get to knitting round a guillotine.

      • I don’t usually comment on the UK as since Brexit it is doomed, but there is a positive to be derived from this phenomenon which is that Insurance companies too will heave a sigh of relief as they see their life and pensions business start to look more affordable in light of increased yields.

        It may also help with sky high motor insurance premiums as, if this continues, Insurance companies will feel under less pressure to search for more revenue from other areas of their business to prop up their life and pensions arms.

    • “As to how high inflation could go without a response from the BOE I think the answer is clear: very!”

      Bob J on October 7, 2016 at 11:15 am said:”I think they will find it very difficult to “look through” inflation a second time;”


  4. I see that The FT readers gave Rogoff both barrels in the comments section, there is no doubt he is divorced from reality.
    On a side note I see the Greeks have been given more money for reaching ‘milestones’. The fact that they only met 2 out of the 15 reforms that they were supposed to make has been brushed under the carpet. The EU doesn’t really want a war on 2 fronts with Brexit now in the mix so another fudge was needed!

    • Hi Bez and welcome to my corner of the world wide web

      There has been some extraordinary hyperbole about Greece over the past 24 hours. Yet more debt is presented as a triumph and the economy as usual is forecast to recover next year. As to reform Pierre Moscovici does not agree with you.

      “This decision was based on a compliance report of the Commission and the other institutions that showed that all remaining 15 milestones had been completed. This included key issues such as on pensions, bank governance, energy, privatisation and the revenue administration. I would like to thank my colleague Euclid Tsakalotos for his efforts and the Greek authorities to complete this work.”

      But I would not be too worried if I was you because he also thinks this.

      “I share the President’s views about the state of the Greek economy, we have quite good news from growth and budget execution.”

      0.9% smaller than a year before is apparently good news for the size of the economy…

  5. Zero reform. Zero policies to help industry. Zero policies to improve housing. Just devaluation and nationalism. That scoundrel Farage claimed he’d provide £350 million for the NHS and promptly reneged. Unfortunately the consequent devaluation and nationalism will hurt the NHS. Many foreign NHS employees will be feeling unpleasant nationalism and racism. Doctors can easily emigrate anywhere and other trained medical specialists can earn more down under or in North America.

    With nationalism, the bottom falling out of sterling starts to appear possible

    • oh come on !

      nationalism is what the Euro Land is about fer gods sake !

      one empire , Franko-German

      nationalism of the Nazi kind ? no , not really here for the UK people I speak to

      We saw the dictatorship of the UE and wanted none of it

      as for the pound this week , well the speculators are out in force

      If at any time mastery inaction is required – its this week


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