The overlooked opportunity in UK gilts

The UK has had almost as many chancellors as Autumn Budgets over the past decade, underscoring a period of remarkable political and economic churn. As Chancellor John Healey prepares to deliver the first fiscal statement of Andy Burnham’s newly formed government, the electorate, the media and bond markets will be analysing every detail. 

UK fiscal policy has come under increased scrutiny in recent years, with concerns over the sustainability of UK debt levels, growth and inflation. This is reflected in elevated gilt yields, with the 30-year gilt yield topping 6% for the first time since 1998 at the beginning of October. The repricing of yields is due to a combination of factors, including inflation, the end of ultra-low interest rates and the withdrawal of central bank support, as well as fiscal concerns. 

Against this backdrop, it is easy to construct a bearish case for gilts. But looking beyond headline numbers, some of the supply pressures that have weighed heavily on the market are beginning to ease, while a substantial portion of the risk is already priced in. The UK’s fiscal challenges are not going to disappear anytime soon, but are gilts more attractive than their reputation suggests?

Debt matters, but so does the deficit

Headlines around the UK’s fiscal sustainability focus on the debt-to-GDP figure of around 95%, over double its near 40% level in 2006. 

However, there are two components of fiscal sustainability: the stock (the overall debt-to-GDP) and the flow (the deficit the government is running and therefore, the amount of new funding the government had to find). While the two are interlinked, it is the debt-to-GDP story that has been getting the most airtime, with the deficit not receiving as much coverage. 

To properly analyse the fiscal situation, we can look at the net funding requirement as a percentage of GDP – this figure takes into account the net deficit, adjusted for programmes of either quantitative easing (QE) or quantitative tightening (QT) undertaken by the Bank of England (BoE).

During the pandemic, government borrowing increased sharply, but this coincided with significant levels of QE, as the BoE strove to shore up an economy plunged into a sharp contraction. This means the central bank was an important buyer of gilts, purchasing £875 billion of gilts during the Covid pandemic. As a result, while engaging in heavy borrowing, the government didn’t need to turn to private investors to fund the deficit because it had a buyer in the form of the central bank.

However, subsequently, the dynamic has become considerably more challenging. From 2022 onwards, the government still had sizeable borrowing needs but the BoE was selling down its gilts at a ferocious pace, reducing its stockpile from a peak of £895 billion in February 2022 to £488 billion in September 2026. Consequently, the BofE is no longer a de facto buyer of gilts, meaning the government has had to turn to private investors to fund their borrowing. 

We believe this explains the sharp repricing in gilt yields as there was a substantial amount of supply for the market to absorb.

Easing pressures

While the starting point of 95% remains challenging, some of the underlying dynamics are beginning to improve and may continue to do so. The net deficit is falling, for example the public sector current budget deficit fell 5.3% in the full year to August 2026.¹

It is not often recognised that it is set to fall further over the next two or three years via fiscal drag. UK income tax thresholds have been frozen since April 2021, and are scheduled to remain frozen until 2031, dragging more earners into the higher tax bracket. As a result, the total tax take as a percentage of GDP is set to rise in coming years. The Office for Budget Responsibility estimates that tax receipts will increase by a combined £29.3 billion a year in 2027-8.²

At the same time, the BoE is expected to slow its running down of QE stock. At its peak, the net run down was £100 billion a year; we are now moving into an era where the net rundown will be £50 billion a year, with run-offs rather than active sales. Consequently, that reduces the amount of gilts that need to find buyers significantly, creating a tailwind. 

In other words, the UK’s fiscal position remains challenging, but the direction of travel in the net funding requirement is arguably more important for gilts than a snapshot of the debt stock alone. In this context, the UK also compares favourably to other highly indebted countries such as the US. While the US has a similarly high debt level, there is currently no policy to bring it down. This suggests treating the UK as uniquely fiscally vulnerable risks overlooking the underlying dynamics.

More yield, less duration

The structure of the gilt market has changed considerably in the past decade. Ten years ago, the average nominal gilt duration was about 12 years, now it is 7.5 years.

Traditionally, UK institutions, such as pension funds, created a strong demand for long-dated assets to match their long-dated liabilities. As this demand has fallen away as DB pension schemes mature, the duration of UK issuance has shortened substantially, while at the same time yields have increased. For example, five years ago, an investor might have bought gilts yielding around 1%, with 12 years of duration. Today, investors are able to buy a gilt with a yield of 5% and a duration of only seven years. As a result, investors have more income to cushion returns and less sensitivity to movements in interest rates. 

Where are the opportunities?

We believe the opportunity in gilts lies not in owning the gilt market indiscriminately, but in hunting out opportunities within the market. An element of term premium has returned to the market, and there are areas of the yield curve which we believe look attractive.  

One way in which we are able to do this through investing in the parts of the curve offering what we perceive as the best rolldown – the capital gain created by the natural fall in a bond’s yield as it approaches maturity, assuming an upward sloping yield curve. We tend to concentrate this in the steepest part of the curve, meaning you could achieve the greatest roll down benefit, as well an gaining the income. 

There are also inefficiencies in the gilt market which we are able to take advantage of. For example, we can employ a butterfly trade which gives us the opportunity to exploit mispricings in the curvature of the yield curve. We also look for single stocks that we believe are mispriced compared to other gilts of a similar maturity. These opportunities may arise as a result of issuance in a certain part of the curve, and bonds moving from being on the run to off the run.

While we believe that the UK’s fiscal situation is somewhat misunderstood, we still believe the strongest advantage for an active investor is in delving into the details and taking advantage of inefficiencies in the market to generate excess return, rather than taking large directional bets.

¹ ONS, ‘Public sector finances’, (ons.gov.uk), August 2026.
² Office for Budget Responsibility, ‘Economic and fiscal outlook’, (obr.uk), March 2023.