We’ve been telling readers for several months that gilts (UK government bonds) look a good buy. Falling commodity and oil prices saw inflation fall sharply last month in both Britain and America. And with deflation now the biggest threat – in the short-term certainly – interest rates are likely to keep falling. In fact, Capital Economics reckons that the Bank of England could cut rates as far as 1% next year. Falling returns on other assets and cash accounts make the fixed coupon and safety of government bonds look increasingly attractive. That means more investors buy gilts, driving up the price (thus driving down the yield).
However, one big worry is that governments across the world, including our own, are gearing up to borrow and spend a lot more to prop up their economies. That involves issuing a lot more debt. If the supply of gilts shoots up, can we really expect further gains for them? Well, if we’re heading for Japan-style deflation, the answer seems to be ‘yes’. In the 1990s, the Japanese central bank tried to kickstart the faltering economy by flattening interest rates, while the government borrowed heavily to spend money on boosting the economy.
Yet despite this leap in government borrowing, Japanese government bond yields continued to fall (see chart) as worried consumers and companies scrambled to put their money in the safest haven they knew. That’s not to say that inflation won’t become a problem further down the line. But for now it seems “entirely possible that government securities yielding 4.5% a year today will be yielding 3% next year, which could see people getting a 40% uplift in capital values”, Hugh Hendry of Eclectica Asset Management tells The Daily Telegraph. “Falling inflation and interest-rate expectations are very supportive for gilts. I think the rally has further to go,” adds Jim Leaviss, manager of the M&G Gilt and Fixed Income fund, on Citywire.
So what should you do? You could buy individual gilts through your stockbroker, in which case Tim Price at PFP Wealth Management recommends shorter-dated bonds “out to say eight years or so”. Or you could buy a specialist gilt fund – the Allianz Pimco Fund is one of the sector’s best-performing. It now yields 4.15%, and is up 17.5% over three years. But for a cheap and simple way to get broad exposure across the gilt market, Price recommends the iShares FTSE UK Gilt ETF (LSE:IGLT), which charges a 0.2% annual management fee.