UK Treasury Minister called to parliament to explain surging Gilt yields

Dhwani Mehta FXStreet

The UK House of Commons said on Thursday that a minister from Britain's Treasury Department has been summoned to parliament to respond to an urgent question about "the growing pressure of borrowing costs on the public finances", per Reuters.

The parliamentary discussion is expected to begin around 1030 GMT, Reuters reports.

This comes after UK gilt yields exploded on Wednesday, with the 10-year yields currently sitting at the highest level since August 2008 near 4.91%.

Market reaction

The above headline fails to offer any comfort to the Pound Sterling, as GBP/USD sheds 0.63% on the day to trade at 1.2283, as of writing.

UK gilt yields FAQs

What are UK Gilt Yields?

UK Gilt Yields measure the annual return an investor can expect from holding UK government bonds, or Gilts. Like other bonds, Gilts pay interest to holders at regular intervals, the ‘coupon’, followed by the full value of the bond at maturity. The coupon is fixed but the Yield varies as it takes into account changes in the bond's price. For example, a Gilt worth 100 Pounds Sterling might have a coupon of 5.0%. If the Gilt's price were to fall to 98 Pounds, the coupon would still be 5.0%, but the Gilt Yield would rise to 5.102% to reflect the decline in price.

What factors influence the level of Gilt Yields?

Many factors influence Gilt yields, but the main ones are interest rates, the strength of the British economy, the liquidity of the bond market and the value of the Pound Sterling. Rising inflation will generally weaken Gilt prices and lead to higher Gilt yields because Gilts are long-term investments susceptible to inflation, which erodes their value. Higher interest rates impact existing Gilt yields because newly-issued Gilts will carry a higher, more attractive coupon. Liquidity can be a risk when there is a lack of buyers or sellers due to panic or preference for riskier assets.

How do interest rates impact UK Gilt Yields?

Probably the most important factor influencing the level of Gilt yields is interest rates. These are set by the Bank of England (BoE) to ensure price stability. Higher interest rates will raise yields and lower the price of Gilts because new Gilts issued will bear a higher, more attractive coupon, reducing demand for older Gilts, which will see a corresponding decline in price.

How does inflation influence UK Gilt Yields?

Inflation is a key factor affecting Gilt yields as it impacts the value of the principal received by the holder at the end of the term, as well as the relative value of the repayments. Higher inflation deteriorates the value of Gilts over time, reflected in a higher yield (lower price). The opposite is true of lower inflation. In rare cases of deflation, a Gilt may rise in price – represented by a negative yield.

What is the relationship between Gilt Yields and the Pound Sterling?

Foreign holders of Gilts are exposed to exchange-rate risk since Gilts are denominated in Pound Sterling. If the currency strengthens investors will realize a higher return and vice versa if it weakens. In addition, Gilt yields are highly correlated to the Pound Sterling. This is because yields are a reflection of interest rates and interest rate expectations, a key driver of Pound Sterling. Higher interest rates, raise the coupon on newly-issued Gilts, attracting more global investors. Since they are priced in Pounds, this increases demand for Pound Sterling.

Author

Dhwani Mehta

FXStreet

Residing in Mumbai (India), Dhwani is a Senior Analyst and Manager of the Asian session at FXStreet. She has over 10 years of experience in analyzing and covering the global financial markets, with specialization in Forex and commodities markets.

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