What are UK gilts and how do you trade them?

downtrend chart
Rebecca Cattlin
By :  ,  Financial Writer

UK gilts have been talked about a lot recently due to the market backlash against the government’s mini-budget in September 2022. Let’s take a look at what a gilt is, how gilts work and why the market fell.


What is a gilt?

A gilt is a UK Government bond issued by the HM Treasury and listed on the London Stock Exchange. UK bonds are called gilts because historically they were issued as paper certificates with a gilt edge, although now it’s said to be in reference to their security.

These fixed-interest securities are usually considered relatively low risk, as the British government has never failed to make interest payments on them – or to pay back the principal payments at the point of maturity.

UK gilts are used to raise money to cover a disparity between the amount needed for public spending and the income being generated by taxes.


How does a gilt work?

A gilt works in the same way as any bond. Investors lend money to an entity – in this case the UK government – for a pre-determined amount of time. They’re essentially an ‘I owe you’ from the government.

Over the lifetime of the loan, the investor receives interest payments, known as the coupon. This is expressed as a percentage of the gilt’s face value. Generally, the greater the coupon payments, the riskier the securities – as more incentive is needed for investors to give the government money.

At the end of the agreement, bond holders get their full investment back. Investors can wait until their gilt expires to receive the full principal, or they could re-sell them on the open market – much in the same way as stocks and shares.

Ultimately, how gilts work differs slightly depending on which type you’re looking at.

Learn more about bonds


Types of gilt bond

There are two types of gilt issued by the UK Treasury department:

  1. Conventional gilts
  2. Index-linked gilts

Conventional gilts

Conventional gilts are nominal bonds that are issued in British pound sterling. They make up around 75% of gilt issuances.

The UK government makes a guarantee to pay gilt holders a fixed-cash payment – known as a coupon payment – every six months until the time of expiry. At this point, the holder gets their final coupon payment and their principal investment back.

Gilts are issued in £100 units, so if you’re buying directly from the Debt Management Office, that’s how much you’d pay. If you’re buying on the open market, the price of a gilt can varies massively depending on supply and demand. If demand is low, they could go for £90, but if it’s high you could pay around £110.

Regardless of the price, the gilt coupon is always based on the original nominal value of £100 and you’d receive your coupon cash payment per £100 that you hold. For example, if you invested £1,000 on a 4% gilt, you’d get 4% of £1,000 – that works out at £40 over the course of two equal payments of £20.

The coupon rate is set at the market interest rate at the time of issuance. But there is usually a wide range of coupon rates available on the open market. This is why demand alters over time – as if there’s a higher interest rate on new bonds, older bonds with lower rates become less popular.

Conventional gilts have specific maturity dates that would always be set upfront and found in the terms of the bond. There are three common maturities: 5-year, 10-year and 30-year gilts. However, the government has previously issued 50- and 55-year maturity gilts.


Index-linked gilts (IGs)

Index-linked gilts (IGs) are bonds in which the coupon rates reflect the real borrowing rates, not just the rate available at the first issue. IGs make up the remaining 25% of gilt issuances.

The UK was actually one of the first developed economies to issue IGs for investors, back in 1981.

Index-linked gilts still have semi-annual coupon payments, but they’re adjusted in line with the UK Retail Prices Index (RPI). This means that both the coupons and the principal paid are adjusted to take inflation into account. A higher inflation rate would result in a higher coupon payment on index-linked gilts.

According to the Debt Management Office (DMO), each coupon payable on index-linked gilts consists of two elements:

  • Half the annual real coupon. The real coupon is quoted in the gilt's title and is fixed. For example, a 1% Index-linked Treasury Gilt 2050 pays a real coupon of 1%, which is ½% twice a year
  • An adjustment factor. This is applied to the real coupon payment to take account of the increase in the RPI since the gilt's issue

These calculations have been performed by the DMO for any gilt issued post-2002. For gilts still in circulation from pre-2002, the inflation calculations are performed by the Bank of England.


What is gilt yield?

Gilt yield is the return on the original investment as a percentage of its current price, calculated by dividing the coupon by the price paid for the bond. It’s commonly called the cost of borrowing – as it’s the amount of interest the issuer will pay.

Gilt yields and gilt prices have an inverse relationship. When yields rise, it indicates a lack of willingness among investors to own the debt. This means that issuing entities have to lower the price of the securities.

Learn more about bond yields


Why did UK gilts fall?

Bond markets in general have suffered alongside the wider economic environment as a result of rising inflation and rising interest rates. However, after Kwasi Kwarteng’s ‘mini budget’ on September 23, there was a market sell off which sparked a liquidity crisis across thousands of pension funds that were invested in the gilt market.

Learn about trickle-down economics policies

When a government announces tax cuts with no decrease in spending, the money has to come from debt. To finance higher borrowing to pay for the tax cuts, an extra £72.4 billion in debt sales was planned for the current financial year. On top of this, the Bank of England had been planning to sell about £40 billion of bonds over the next year to wind down its quantitative easing programme.

This sent yields on UK 10-year gilts above 4% – which marked the highest level since 2008 and is more than triple the rate at the start of 2022, 1.3%. When yields rise by so much, it indicates that the market attitude has soured to such a point that prices would have to be incredibly low for investors to support the government debt.

The Bank of England restored some credibility to the bond market by offering to buy a max of £5 billion in government bonds a day until October 14. However, this might not be enough to sure up the gilt market in the long term.

When speaking to the Financial Times, Head of Fixed Income at Union Investment Christian Kopf said:

              “We’re going to be much more reluctant to put on big trades in gilts any more…It has become an unpredictable market with populist policies. Even if the Bank of England has [fixed the plumbing] you are still left with an inconsistent fiscal policy.”

However, Hargreaves Lansdown reported that a lot of retail investors were still buying gilts to take advantage of the higher yields after the sell-off.

Despite a U-turn from the government on the 45% tax cut, UK financial credibility is expected to still be damaged, according to credit rating agencies. While the decision was met with a brief rise in sterling, investor concern remains more focused on government instability – especially as the rest of the proposal still requires taking on high levels of debt.


How to buy and sell gilts

Traditionally, you’d buy government bonds either directly from the Debt Management Office (DMO) or from other investors on the London Stock Exchange. You could then sell the securities on the open market, or wait until the date of maturity to collect the principal.

Another common option for retail investors is to invest in fixed-interest securities via exchange-traded funds.

With City Index, you can speculate on the price of government bonds and ETFs using derivatives. You’d take a position on whether gilts are going to rise or fall in value, and your profit (or loss) would be determined by how far the market moves in your favour.

To start trading gilts and other government bonds with City Index, you’ll need to:

  1. Open a City Index account, or log in if you’re already a customer
  2. Explore our bonds markets in our award-winning platform
  3. Choose your position and size, and your stop and limit levels
  4. Place the trade

Or you can try trading bonds risk free by signing up for our demo trading account.



Related tags: Bonds gilts UK Insights

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