What rising UK bond yields really mean for your savings, mortgage and pension

Thirty-year UK government bonds yields have climbed above 6 per cent recently, reaching their highest level since 1998 - nearly three full decades.

This might sound like something that matters only to City investors, but movements in the bond market - or gilts, as those issued by the UK government are known - can feed through into everyday finances: from the interest you earn on savings, to the rate you pay on your mortgage.

The latest rise has been driven by fears that inflation could remain stubbornly high due to elevated oil prices and concerns about government borrowing.

So what exactly are gilts, and why should you care if you don't own any?

What are gilts?

Gilts are essentially loans to the UK government. When you buy one, you lend the Government money in return for regular interest payments (the yield). At the end of the agreed term, your original investment is repaid.

Gilts can be bought and sold before they mature, and their market price moves according to factors including interest rates, inflation and investor demand.

A 30-year gilt yield around 6 per cent means investors are demanding a relatively high return for lending to the Government over three decades.

You might think that higher bond yields only matter to investors who hold bonds. But as we’ll see, this isn’t true.

Could higher gilt yields mean better savings rates?

Potentially, yes. When bond yields rise, banks and building societies can face pressure to offer more competitive rates to attract savers and raise funding.

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That can be good news if you have money sitting in a savings account, particularly after several years in which inflation has eaten into the spending power of cash.

Dan Coatsworth, head of markets at AJ Bell, says: “When bond yields rise, savings rates tend to follow.

“That gives savers a better return on cash, but it also raises the hurdle for other investments because investors can earn a decent income without taking much risk.”

What does it mean for mortgages?

Rising gilt yields could potentially be more painful for homeowners. Fixed mortgage rates, set by individual lenders, are influenced by wholesale funding costs and swap rates, which are closely linked to future expectations for interest rates and government bond yields.

When those costs rise, lenders can increase the rates they charge borrowers.

Rachel Springall, finance expert at Moneyfacts, says the recent rise in yields has already put pressure on mortgage pricing.

She says: “The impact on sub-5 per cent fixed mortgages has been brutal, with around 1,500 deals priced below that level vanishing since the start of September.”

The average five-year fixed rate mortgage reached 6 per cent in early October, with the average two-year deal not far behind.

“Average fixed mortgage rates have not been above 6 per cent for around three years,” Ms Springall added. “Those coming to the end of a fixed deal would be wise to seek advice and compare deals carefully, particularly as borrowers could secure a new deal a few months before their existing mortgage ends.”

What about shares and pensions?

There’s also a knock-in into different investment options. “Higher gilt yields make bonds a more attractive alternative to shares,” says Mr Coatsworth. “When investors can earn a relatively high return from government debt with limited risk, equities (like shares) must work harder to justify their additional volatility.”

That doesn't mean the stock market will automatically fall when gilt yields rise. Company profits, economic growth and investor confidence also play major roles.

Gilts are widely held by pension funds, so changes in gilt yields can affect pensions too.

The impact depends on the type of pension and what it invests in: Defined benefit (DB) schemes are particularly sensitive because bond yields are used to value their future liabilities. For defined contribution (DC) pensions, the effect is less direct and depends more on the investments held.

Bonds and the Budget

Chancellor John Healey’s budget is coming up on 28 October and gilts will be firmly in the spotlight.

Andrew Prosser, head of investments at InvestEngine says: “Rising gilt yields make life a lot harder for John Healey before he has even stood up at the despatch box. Higher borrowing costs mean less room to manoeuvre, and every decision in this Budget will be closely watched by the bond market.”

There’s also a tax angle. Gilts held directly are exempt from Capital Gains Tax (CGT), which could become more valuable if CGT rates change in the Budget. And if gilt yields fall, prices should rise, allowing investors to make a tax-free capital gain as well as earn income from the gilt.

For ordinary households, the message is that gilts aren't some remote City concern. Their yields can influence the cost of borrowing, the return on savings and the performance of investments and pensions.

And while you can't control what happens in the gilt market, you can make sure your own finances aren't caught completely off guard by it.

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.