Chancellor Rachel Reeves provided an update on the UK’s finances in the Spring Statement. It was intended to reassure people, but the reality is the country will be running up more debt over the next few years. This affects interest rates, government bonds (gilts) and, potentially, UK equities.

Some clients have enquired whether the latest announcements are detrimental for gilts, and the chart below shows that gilt yields rose in the lead up to the Autumn Budget and the initial run-up to the Spring Statement. This means gilts have delivered a negative performance over this period.

However, we believe that investors taking a negative view on gilts may be overlooking some important points.

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The Chancellor says the government is fixing the UK’s financial problems, but most of the big changes will not happen for a while. This means the country’s debt will keep growing in the short term. In addition, we expect the government to increase the tax burden later this year. Instead of increasing tax rates, it may freeze tax thresholds again, so people end up paying more as wages rise.

It is clear the economic backdrop is challenging – and this is, in part, why we see an opportunity in gilts.

Four reasons to be positive on gilts  

01. Fewer than expected long-term gilts are to be issued

Shortly after the Spring Statement, the Debt Management Office, which issues UK government bonds, announced it was reducing the number of long-term gilts it plans to sell. This helps keep gilt prices stable.

02. The UK economy is slowing down

Fewer jobs are available, and businesses are struggling. A weaker economy usually means interest rates go down, which helps government bonds perform better.

03. Inflation is falling

Inflation is falling, and with the economy slowing, the Bank of England may cut interest rates faster than currently forecast. If this happens, gilts are to likely perform better than expected.

04. Gilts look undervalued

We believe gilts look undervalued at current prices. They are also cheaper than US government bonds. If the economy gets worse, and interest rates are cut, UK government bonds could become even more attractive.

In our view, the market may be overreacting – investors may be too negative about gilts, creating a potential buying opportunity.

Key takeaway:

If the economy slows, inflation eases and interest rates fall, UK government bonds may surprise for the right reason.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.