What is going on with the UK Gilt Curve?
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Article Type
BondTalk
Topic
Opinion
Published
April 24, 2025
Read time
5 mins
Author
James Lynch, CFA
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UK curve versus Bank of England base rate

Source: Bloomberg 2025

 

The difference between the yield on a five year government bond and a 30 year government bond is now 130bps (1.3%), this is the steepest level of curve since 2016.

 

Typically, as you can see from the chart above, when interest rates are higher you have flatter curves and when interest rates are lower you have steeper curves. This makes intuitive sense as when current interest rates are on the floor - such as in 2016 when they were 0.5% - the future path for interest rates has to be higher which leads to a steeper curve. The opposite is true when current interest rates are high such as now at 4.5%; if rates are going higher then surely we should have a flatter curve? But that is not the case; we are getting a steeper curve as long end interest is going in the opposite direction to short term interest rates.

Like most things in life, the answer is not entirely simple. There are a number of different factors;

 

  • The market expects lower interest rates for the next 18 months;
  • Higher long end interest rates from the Unites States Treasury market are having an effect;
  • Investors want a higher premium for holding long term bonds;
  • Investors want a higher premium for holding gilts;
  • UK’s large fiscal deficit will mean large supply of gilts for years to come;
  • Demand is shifting away from domestic to international buyers.

 

In part these reasons for the current shape for the UK gilt curve are intertwined. The state of the public finances means extra borrowing of around 300 billion a year in gilts. These are large numbers and so investors do not need to worry about the scarcity value of gilts, there will be plenty to go around. Indeed, as long end gilt yields rise, this will impact the deficit numbers by making the interest costs worse for the government, requiring more gilts!

 

Related to the worse UK deficit numbers, the underlying issue is the weak GDP growth numbers which has meant an increase in gilt borrowing along with the introduction of new fiscal rules (which may be challenged at some point this year). The other effect of the worsening economic outlook is the market looking to the Bank of England to lower interest rates to stimulate demand in the economy, meaning shorter dated gilts, which are more sensitive to bank policy rate increase in price/fall in yield which causes the gilt curve to steepen up.

 

At the same times as the supply of gilts is increasing, domestic buyers are not there as much as they used to be. Of course, we had years of the Bank of England buying bonds through Quantitative Easing, and now they are sellers as they try to reduce the balance sheet. In addition, UK pension funds are in a better place meaning they no longer require to derisk their portfolios as much as the past and so they have less need for gilts. Instead the demand has come in from overseas investors who generally prefer safer, shorter dated bonds than longer dated - they will buy the long end, they just require a higher level of yield to be interested.

 

Another important factor facing long end bonds has been the impact of US Treasuries. With uncertainty in US economic policy, investors have required higher premia for holding long dated US bonds. In the US the difference between five year and 30 year yields have moved from 40bps to 80bps since March. Being the worlds largest bond market, they tend to set the bar for where global rates should be, so no doubt this has also had spillover effects onto the gilt market.

 

It appears that the fundamental reasons for having a steep curve will not be changing anytime soon; low growth, increasing deficits and higher gilt supply. If the Bank of England does not cut interest rates as much as the market expects then perhaps that will flatten the curve but we would still expect higher long end gilt yields in that environment. Perhaps there could be short term relief if global factors mean the long end of US Treasuries move significantly lower in yield but we would still expect the fundamental factors to win out over the longer term.

Important Information

Author

James Lynch, CFA
Portfolio Manager

James Lynch, portfolio manager, is a member of the global rates team and is responsible for co-managing the UK government bond, segregated absolute return bond, long government bond and inflation-linked government bond portfolios. .

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