UK gilts explained: how government bonds connect to your mortgage rate

What the source announced

A gilt is a UK Government liability denominated in sterling, issued by HM Treasury and listed on the London Stock Exchange (DMO, About Gilts). The term 'gilt-edged' captures the instrument's defining characteristic as an investment: the British Government has never failed to make interest payments or principal payments on gilts as they fall due (DMO, About Gilts).

The gilt market comprises two types of securities — conventional gilts and index-linked gilts (DMO, About Gilts). A conventional gilt is a liability of the government under which it guarantees to pay the holder a fixed cash payment (coupon) every six months until the maturity date, at which point the holder receives the final coupon payment and the return of the principal (DMO, About Gilts). The price of a conventional gilt is quoted per £100 face value (DMO, About Gilts).

The coupon rate on a conventional gilt typically reflects the market interest rate at the time of first issuance (DMO, About Gilts). The coupon itself indicates the cash payment per £100 nominal value that the holder will receive per year (DMO, About Gilts), paid in two equal semi-annual instalments on fixed dates.

The UK was one of the earliest developed economies to issue index-linked bonds to institutional investors, with the first issue taking place in 1981 (DMO, About Gilts). Index-linked gilts differ from conventional gilts in that both the semi-annual coupon payments and the principal repayment are adjusted in line with the UK Retail Prices Index (RPI) with a lag (DMO, About Gilts). Both coupons and the principal repaid on redemption are adjusted to account for accrued inflation since the gilt was first issued (DMO, About Gilts).

What this means for your mortgage

The coupon rate usually reflects the market interest rate at the time when the gilt is first issued. This is why fixed mortgage rates can move sharply even when the Bank of England base rate has not changed.

Index-linked gilt payments — coupons and principal alike — are adjusted for RPI inflation accrued since issuance (DMO, About Gilts). Their presence in the gilt market reflects that long-term UK borrowing costs are not insulated from the path of inflation: the same inflation-sensitive pricing environment that index-linked gilt cash flows inhabit is one that lenders weigh when setting rates on longer fixed-rate mortgage terms. Calculate your fixed-rate mortgage payments →