What is a bond?
A bond is an IOU or loan made by an investor to a government or company that must be repaid in full at a set date in the future.
The investor also receives a fixed rate of interest on the loan over its term.
What are bonds used for?
The Government issues bonds, also known as gilts, to fill the gap between public spending and tax receipts.
If the interest rate is fixed, why do bond yields go up and down?
Bonds are traded between investors, who take a view on how creditworthy the Government is.
The riskier they see the bet, the higher the price – or yield – they demand.
So higher bond yields are a bad thing?
Generally, yes. Higher bond yields increase the cost of government borrowing.
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In other words, its debt interest bill goes up, soaking up money that could be spent on public services likes schools, hospitals, welfare and defence.
Do bond prices affect mortgage rates?
Yes. Banks and building societies price their fixed-rate home loans – the most popular form of mortgage – off bond yields.
It means borrowers face higher interest repayments if, for example, they want to renew their two or five year fixed rate mortgage deal.
Tracker mortgages move in line with interest rates set by the Bank of England and are not directly affected by bond yields.
What does it mean for savers?
Bond prices reflect a number of factors, including interest rate expectations.
So when bond yields rise it means investors think interest rates may go up – or at least stay higher for longer, as is the case today – which is good news for savers.
What about the pound in my pocket?
Higher-for-longer interest rates ought to mean a stronger pound, which would be good news if you are going abroad.
But sterling has weakened against the dollar recently on fears US inflation will jump under President Donald Trump, keeping American borrowing costs high.
Any other winners and losers?
Yes. Higher bond yields are bad news for those in default ‘lifestyle’ workplace pension schemes, which move members out of equities and into supposedly ‘safer’ bonds as they approach retirement.
That’s because bonds, which promise to pay the holder a fixed income if held to maturity, fall in price as their yields rise.
The flip side is that annuity rates, which guarantee a retirement income, become more valuable when bond yields rise.
In other words, you can buy the same annuity for less – or more income for the same outlay.
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