DO UK BONDS OFFER VALUE?

29.05.2025 With the 10 year UK government bond yielding an interest rate of around 4.75% I look at whether bonds offer value for investors.

The price of bonds is heavily influenced by the outlook for interest rates. At present the key issue for UK monetary policy is high wage growth that has fed through into service sector inflation of around 5%. With the inflation target set at 2%, service sector inflation has limited the speed at which UK interest rates have fallen.

High UK wage growth reflected strong post pandemic demand for Labour and high headline inflation. Both have now normalized with job vacancies having fallen nearly 40% from their peak. Surveys suggest that pay settlements this year have been between 3% and 4%. So average weekly earnings should decelerate significantly from the current 5.6% rate.  This should mean that the Bank of England will be able to start cutting interest rates again in the Autumn.

Whilst the outlook for underlying inflation in the UK is improving interest rates and the prices of government bonds are also influenced by the amount the government want to borrow. Following the Trump budget, that could add as much as USD 3.8 tn to the US government’s liabilities, fiscal sustainability is an increasing focus for the markets. This year the UK government wants to borrow GBP 309bn or GBP 141 bn after redemptions (old debt that has to be refinanced).

UK markets are signaling that they would prefer the government to borrow less. However, this seems unlikely in the short term. Tax rises were ruled out by the current Labour government at the last election. While its appetite for spending cuts seems to be limited e.g. the u turn on the axing of winter fuel payments to pensioners.

10 year UK government bonds, which yield around 4.75%, offer good value relative to the inflation target of 2%. Furthermore, slowing wage growth suggests that interest rate cuts should restart in the autumn. However, concerns about the scale of government borrowing and the overall debt level are unlikely to be resolved soon. This is likely to limit the scope of any rises in the price of UK bonds.

For information only. Investors should seek professional advice for their own circumstances before making an investment.

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This post was written by Robin