UK government bond (gilt) yields reached their highest level since 2008 – over 3% - with the expectation that the recent hikes in interest rates will continue.
Experts say UK short-dated gilt yields at 14-year highs can be attributed to the highest inflation level - of 10.1% - seen in 40 years as Russia’s invasion of Ukraine has sent energy prices rocketing.
Gilts (or Treasury bonds in the US) are units of debt issued by the government and when buying them you are effectively lending money to the state, with the promise of being repaid the full amount at a specified date and usually with a fixed coupon (interest rate).
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As gilts are loan notes issued by the UK government they are regarded as essentially safe bets with little or no chance of default.
But that does not mean they have no risk, with the biggest curse of fixed bonds being inflation.
To control inflation, central banks traditionally raise the base rate to curb spending with new bond issues reflecting the higher rate of interest.
In anticipation, investors sell, prices in the market fall and interest rates on bonds rise - especially among longer maturity bonds that will have higher yields but greater scope for their value to be eroded over time by inflation.
In response to surging inflation levels – tipped to hit 22% in January by Goldman Sachs (NYSE:GS) - the Bank of England has already started to raise interest rates to slow economic activity and bring down prices.
Why does this matter?
It costs the government (a lot) more money through higher interest payments to service its debt - funds that might be used to help people with energy bills, for example.
Many funds use bonds as the basis of their projection for future payments – pensioners, also usually on fixed terms, are among the worst affected by inflation.
Higher yields are also considered a bad sign with regard to sovereign debt, with some countries paying bond interest of as much as 49% (Argentina) and 16% (Turkey).
What next?
Gilt yields hit 3% on Monday in the expectation that they might go a lot higher.
Citigroup, for example, predicted rates would have to rise to 6-7% to curb the current rise in prices.
That would be a major headache for the government with debt currently at £2.4trn and rising, even before a new Prime Minister unveils what the plans are to deal with the energy crisis.