Bond market turmoil – but there might be a silver lining for savers

You may have heard the chatter about bond market turmoil this week and wondered whether it spells trouble for you.

UK government bond yields – known as gilt yields – have climbed sharply, with the yield on 30-year gilts recently rising above 6% for the first time since 1998. Ten-year gilt yields also reached their highest level since 2007.

That might sound like something that only matters to investors or the Government. Unfortunately, it doesn’t.

The gilt market has an important influence on the wider financial system, so movements in gilt yields can eventually feed through into the rates offered on mortgages, savings and pensions.

But there is a potential silver lining for savers.

What exactly is a gilt?

But first, a quick refresher on gilts, bonds and their significant. A gilt is essentially an IOU issued by the UK Government. When the Government needs to borrow money, it can issue gilts to investors. In return, investors receive interest and eventually get their original investment back when the gilt matures.

The gilt yield is the return an investor can expect to receive from holding that government debt, based on its current market price.

The important thing to understand is that gilt prices and gilt yields move in opposite directions. When gilt prices fall, their yields rise – and that is what has been happening recently.

Why are gilt yields rising?

There are several reasons, but investors have become increasingly concerned about inflation, government borrowing and the outlook for interest rates.

There are also fears that higher energy prices could keep inflation elevated, making it harder for the Bank of England to cut interest rates – and potentially increasing the chances of rates rising again.

The Bank of England has already warned that higher global energy costs could push inflation higher and said it may need to raise Bank Rate if inflation remains persistent. Bank Rate is currently 3.75%.

Markets therefore expect interest rates to remain higher for longer than previously hoped.

That has pushed up yields on government bonds.

Why does that matter to you?

Because gilts don’t exist in isolation.

Government bond yields form an important part of the wider interest-rate environment. The Bank of England says that changes in market interest rates feed through into the rates faced by households and businesses.

That can have very different consequences depending on whether you are borrowing or saving.

If you have a mortgage

Higher market interest rates can mean more expensive mortgages, particularly for people coming off a cheap fixed-rate deal or those with variable or tracker mortgages.

The Bank of England’s latest analysis found that rising market rates had already pushed up quoted mortgage rates, with millions of households expected to see their mortgage repayments increase as fixed-rate deals expire.

So the bond market turmoil is certainly not good news for everyone.

But if you have savings…

The picture could be rather different.

Higher interest rates generally mean banks and building societies have to offer more attractive rates to persuade people to keep their money with them.

The Bank of England explains that savings rates are influenced by Bank Rate and competition between financial institutions for deposits.

And we’re already seeing some evidence of this.

This month, we’ve seen the top five-year fixed savings rate reach 5.35%, while one-year fixed rates are available above 5%. That’s the highest we’ve seen these rates in years.

So while rising gilt yields may sound alarming, they could create opportunities for people with cash savings.

Could annuities benefit too?

There is another potential silver lining for people approaching retirement.

Annuity rates are influenced by interest rates and other market factors. The rate an insurer offers depends partly on current interest rates and wider market conditions.

That means a higher-interest-rate environment can potentially translate into more attractive annuity rates. For someone using a pension pot to buy a guaranteed retirement income, this can be significant.

For example, a 5% annuity rate on a £100,000 pension pot would provide £5,000 a year, while a 6% rate would provide £6,000.

Of course, you shouldn’t choose an annuity simply because rates are high. Your health, age, pension size, desired income, inflation protection and death benefits can all affect whether an annuity is right for you.

But it is another example of how the same interest-rate environment can have winners as well as losers.

What should savers do now?

Use the current environment as a prompt to check whether your cash is working as hard as it could.

• Check the rate you’re currently earning

Don’t assume your existing bank or building society is paying a competitive rate. Some easy-access accounts pay significantly more than others, while fixed-rate accounts can offer higher returns if you are prepared to lock your money away.

• Think about when you’ll need the money

Don’t automatically chase the highest rate. If you might need your money in the next few months, an account with easy access could be more appropriate. If you know you won’t need it for one, two or five years, a fixed-rate account could potentially offer a higher return.

• Check your tax position

Interest from savings can be taxable if it exceeds your Personal Savings Allowance, although savings held in an ISA are generally tax-free. This becomes increasingly important when savings rates are higher because you can earn more interest before you reach your allowance.

• Don’t forget about protection

If you have substantial cash savings, check how much you hold with each banking group. Eligible deposits are generally protected by the Financial Services Compensation Scheme (FSCS) up to £120,000 per person, per authorised institution.

• Don’t confuse saving with investing

A higher savings rate can be attractive, particularly if you need your money within the next few years. But if you’re saving for a long-term goal such as retirement, simply putting everything into cash may not necessarily be the right approach.

Investments can offer the potential for higher long-term returns, but they also come with the risk that their value can fall. The right balance between cash savings and investments depends on your circumstances, goals and attitude to risk.

The bottom line

The words “bond market turmoil” can make it sound as though the whole story is bad news.

It isn’t.

Higher gilt yields can put pressure on Government finances and borrowing costs, and they can contribute to higher mortgage rates. But for savers, it can create opportunities to earn more interest on your cash – and potentially improve annuity rates for people approaching retirement.

If you haven’t checked your savings rate recently, now could be a very good time to do it. Use our Best Cash Savings Accounts page to compare and find top rates. And our Best Cash ISA page if you’re looking for the most tax-efficient way to save.