Government Bonds And Why They Are In The News
27 October 2022
Government Bonds have been making the news recently, particularly in the United Kingdom (where Government Bonds are called Gilts). A Government Bond is how a country borrows money. For example, if you purchase a ten-year Government Bond you lend that Government the money and in return, they pay interest on that money each year. This interest rate is usually called the coupon on a bond.
In Ireland one of our biggest problems, when we got bailed out by the EU and the IMF, was the coupon on our Government Bonds. In September 2010 it cost the Irish Government 6.023% per annum for an eight-year Government Bond and 4.767% for a four-year Government Bond. This was unsustainable which forced the Irish Government to cancel remaining Bond auctions and eventually lead to us getting bailed out when we sought help from the European Union and the IMF in November of that year.
Ireland did not sell any further Government Bonds until March 2013. The interest rate on a 10-year Irish Government Bond is currently 2.789%. The impacts of inflation and moves the ECB have made to try and slow down inflation has caused an increase in Government Bond interest rates all over the world. In January 2022 the interest rate on an Irish 10-year Government Bond was 0.25% however there is no need to worry right now as our current interest rate is similar to the 10-year German Government Bond interest rate which is 2.273%. The German Economy would be viewed as one of the strongest and most stable in Europe.
A Government Bond coupon will increase to unpayable levels when that country is in trouble economically and is viewed as high risk. A Government Bond is a promise to return money in the future and the higher risk a country is the higher the interest rate will be on its Government Bonds compared to its peers. This is due to the threat that they might not be able to pay some or all of that Bond back.
The United Kingdom has had problems in their Government Bond market for the last few weeks. Interest rates on their bonds were increasing (as they are all over the world) however the mini budget announced on the 23rd of September sent the markets, especially the Government Bond market, into a panic. The interest rates on new UK Government Bonds increased, the value of existing UK Government Bonds crashed, and the pound plunged.
The Defined Benefit Pension sector suffered as they had high exposure to Government Bonds. The panic in the markets threatened to sink some of these Pension Funds which meant the Bank of England had to step in to try and decrease the interest rate on the 30 year Government Bond in particular. The Bank of England purchased Government Bonds in an attempt to restore order which has settled markets along with the new Chancellor Jeremy Hunt reversing the changes that were announced in the mini budget which caused the panic.
Rishi Sunak being voted in as the new Prime Minister has also settled markets as it is viewed that he has more of an understanding of economics compared to Liz Truss. The interest rate on the 30-year Government Bond rose to 5.171% at its highest and it is currently 3.704%. The UK political arena is very volatile at present and if you have an interest in what is happening a good indicator is keeping an eye on the interest rate/ coupon on the 30 Year Gilt.
However, it is expected that the current relief rally of the markets will be over sooner rather than later because the U.K. still faces a torrid of economic problems. There’s the impending recession, soaring energy prices, inflation running at more than 10%, labour gaps, ongoing supply chain dramas, and the Bank of England intent on hiking interest rates.
Marie Carr, CFP® MSc BBS QFA RPA SIA is a CERTIFIED FINANCIAL PLANNER. You can contact her through John F. Loughrey Financial Services by telephone on 074-9124002 or by email on email@example.com