2022 was a difficult year for many investors, so it has been a breath of fresh air to have so many reasons to be positive about investments in 2023.
The year so far has seen the:
- FTSE 100 surge to new heights
- Japanese market boom
- AI sector continue to see significant growth
- UK bond market recover and rebound in a positive direction.
FTAdviser reports how, following the UK government’s mini-Budget announcement in September 2022, the value of UK bonds crashed by £1.2 trillion and put UK pension funds at risk. It was one of the most difficult years in recent memory for bond markets.
Yet, 2023 has been a different story so far, with figures from Trading Economics showing that UK 10-year bond yields hit a high of 4.75% on 17 August 2023 – the highest since the 2008 financial crisis.
Read on to discover what you need to know about UK government bonds, why they are soaring this year, and what you might want to consider before opting to invest in them.
Government bonds are a type of debt-based investment that can benefit from rising interest rates
A government bond is a form of investment that represents debt, issued by a government, and sold on to investors to help support government spending.
Governments typically issue bonds to help raise funds to spend on new projects or essential infrastructure, while investors can benefit from the stability of set returns paid at regular intervals.
The money you “loan” to the government in the form of the bond is done so at an agreed rate of interest.
These fixed bond payments are often referred to as “the coupon” and are normally paid out until the bond matures.
Government bonds are usually considered low-risk investments since the corresponding government normally backs them.
The market value of government bonds is usually affected by the rules of supply and demand. This means that a bond’s price has a tendency to fluctuate.
Bond yields typically benefit from periods of rising interest rates
The three primary factors that usually affect a bond’s price are:
- Its yield
- Its rating
- Wider interest rates.
The price of a bond normally reflects the value of the yield remaining within the bond. For example, a bond with a yield of 3% will likely have a lower price than a bond yielding 6%.
Rising interest rates can influence bond prices and these yields. Higher interest rates normally lead to a drop in the price of bonds.
This is because of the inverse relationship between bond prices and interest rates. For example, most bonds pay a fixed interest rate that may become more attractive to investors if nationwide interest rates fall, driving up demand and the price of the bond.
Conversely, if interest rates rise, the now lower fixed interest rate paid by a bond could become less attractive, resulting in a decline in the bond’s price.
The Bank of England (BoE)’s base rate sits at 5.25% as of 12 September 2023 following 14 consecutive increases in the rate. This could present an opportunity for investors to acquire bonds at a lower price than usual and reap the benefits in the long term when interest rates eventually drop, which will likely conversely cause the price of bonds to go up.
So, with that in mind, what should you consider before opting to invest in UK government bonds?
3 important things to consider before investing in UK government bonds
As with any investment opportunity, it is important that you weigh up the various pros and cons before deciding to invest.
Here are three things you might want to consider first, such as:
- Do you have an emergency fund in place to provide for essential outgoings?
- Are you prepared to stay invested over a long-term period? For example, a 10-year bond won’t repay the value of your initial investment until the bond fully matures, even if you earn from “the coupon” in the meantime.
- Rising interest rates might offer you bond investment opportunities, but could also put added pressure on your finances by increasing the cost of flexible-rate debts. It is important you carefully consider your debt obligations, such as credit or mortgage agreements, and the effect of high interest rates on them, before investing any funds.
It is important that whatever you decide to do with your investments, they are aligned with your tolerance for risk and long-term goals.
Get in touch
If you are interested in investing in bonds, but want to gain a greater understanding of how they work and whether they fit into your overall plans, it might be worth reaching out to an expert.
Please email us at email@example.com or call 0345 505 3500.
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.