Summary and conclusions
The Bank of England’s Official Rate, often described as
the Base Rate is presently 0.1%. The
yield on government securities with two years to maturity was 0.04% at the close
of business on Thursday, and with ten years to maturity was 0.73%. [1]
Yield is a function of income to be paid and price, and whilst the yield or a yield to maturity that an investor will experience with a buy-and-hold strategy is fixed at the point of purchase, variations in price will lead to changes in the market value of an asset.
In terms of the expected movement in yields, we set out below how we expect yields to evolve in periods out to end 2022:
Source: CCLA
As can be seen, we expect bond yields to remain broadly unchanged, and we expect credit spreads, the risk premium associated with lending to entities that are deemed less credit-worthy than government to remain broadly unchanged in the period ahead.
We would however caution that we see the spreads of less-credit worthy entities failing to reflect some of the balance sheet and profit and loss risks that have built over the years, and/or been driven by the Covid-19 lockdown measures and associated stresses.
Discussion
We
expect that the primary drivers of bond yields in the period ahead will be the
policies of central banks and governments. In the US, we expect a strong
acceleration of economic growth and rising bond yields – we are expecting the
10 year US Treasury bond yield to rise to around 2.5% by the end of this year,
and then perhaps to 3% next year, but in contrast we expect the Bank of England
to keep a lid on gilt yields as part of so-called Modern Monetary Theory,
whereby central banks hold bond yields down to allow governments to issue debt
with low cost.
Our expectation that the Bank of England will
keep yield stable and low reflects our assessment that with the UK economy
having contracted the best part of 10% last year in real terms, it will still
be some 4% points smaller at the end of this year than it was at the end of
2019, and it will not retake the 2019 high until end 2022. We set out our
current assumptions for the key UK economy variables in the table below.
