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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.

Source: CCLA

Growth of the Public Sector Net Borrowing requirement can be expected to slow this year and next with gilt redemptions dropping to £79bn in 2021/22, down from £98bn in 2020/21, and the reduced level of borrowing will make the impact of the Bank of England’s asset purchases (quantitative easing), greater than it might otherwise have been. 

Whilst we expect gilt yields to hold steady at around current levels, we expect an upward bias to yields through to end 2022, delivering small capital losses, and with inflation accelerating, we expect real returns to be poor. For noting, the inflation forecasts provided in the table are period averages, and we expect the year-on-year CPI inflation rate to top 2% for a couple of months this year.

This document is issued for information purposes only. It does not constitute the provision of financial, investment, or other professional advice. The market review, analysis, and any projections contained in this document are the opinion of the author only and should not be relied upon to form the basis of any investment decisions. CCLA strongly recommend you seek independent professional advice prior to investing. Any forward looking statements are based upon CCLA's current opinions, expectations and projections. CCLA undertake no obligations to update or revise these. Actual results could differ materially from those anticipated.