Gilts: UK Government Bonds

Introduction

If UK finance has a foundation stone, it is the gilt. When the British government spends more than it raises in tax, it borrows the difference by issuing gilts — and the price investors demand to lend sets the reference point for almost everything else in the UK economy. Your fixed-rate mortgage, the annuity rate offered at retirement, the discount rate applied to a British company's future profits: all trace back, directly or indirectly, to what gilts yield.

This article assumes you've met the general mechanics in Bonds — coupons, maturity, and the crucial inverse relationship between price and yield. Here we focus on what makes gilts specifically: the three types the UK issues, why the 10-year gilt is the number everyone quotes, the unusual tax treatment that has no equivalent in most markets, and the lesson of 2022.

Quick Definition

A gilt is a bond issued by the UK government. It pays a fixed coupon (usually twice a year) and repays its face value at maturity. Gilts are issued by the Debt Management Office on behalf of HM Treasury, and are considered the safest sterling investment available.

Why "Gilts"?

The name is a piece of financial history. UK government bond certificates were once printed with gilded edges — literal gold leaf — to signal their standing as the most secure investment obtainable. They became known as gilt-edged securities, shortened over time to "gilts".

The name stuck because the underlying idea did: a government that borrows in its own currency, and can ultimately raise tax or create money to repay, is about as close to certain repayment as finance offers. That's why gilt yields serve as the UK's risk-free rate — the baseline every riskier investment must beat.

Gilts are named with a plain convention: "4% Treasury Gilt 2034" tells you the coupon (4% of face value per year) and the year it matures. Nothing more mysterious than that.

The Three Types

Most countries issue one or two flavours of government bond. The UK issues three, and the differences matter.

Conventional gilts are the bulk of the market. They pay a fixed coupon twice a year and repay face value at maturity. Simple, predictable — and completely exposed to inflation, which quietly erodes the real value of every fixed payment.

Index-linked gilts ("linkers") solve exactly that. Both the coupon payments and the final principal are uprated in line with a measure of inflation — historically the Retail Prices Index, with a planned alignment to CPIH later this decade. A linker doesn't promise you a fixed number of pounds; it promises you a fixed amount of purchasing power. That makes them fundamentally different instruments, and their prices respond to changes in real yields and inflation expectations rather than nominal rates alone.

Green gilts, first issued in 2021, carry conventional terms but commit the proceeds to environmental projects. Financially they behave like conventional gilts; the difference is in what the borrowing funds.

Gilt Yields, and Why the 10-Year Matters

A gilt's yield is the return you'd earn buying at today's price and holding to maturity. Because the coupon is fixed, price and yield move in opposite directions — the see-saw explained in Bonds. If gilt prices fall, gilt yields rise, and vice versa.

Gilts are issued across a wide span of maturities, and the yield at each point tells a different story.

The 10-year gilt yield is the number quoted in news reports, and for good reason. It is the UK's benchmark long-term borrowing cost: it feeds into how fixed-rate mortgages are priced, what companies pay to borrow, and the discount rate applied when valuing UK assets. When commentators say "borrowing costs rose", they usually mean this. The 30-year gilt matters especially to pension schemes and insurers matching very long-dated liabilities, while short-dated gilts track Bank of England policy closely.

The overall shape of these yields is the UK's version of the yield curve — and its slope carries the same signalling power.

The Tax Treatment That Makes Gilts Distinctive

Here is the feature with no real equivalent in most markets, and the reason gilts behave differently from other bonds in British portfolios.

For individual UK investors, gains on the price of a gilt are exempt from Capital Gains Tax. The coupon, however, is taxable as savings income in the normal way.

That split has a striking consequence. Two gilts maturing on the same day can be taxed very differently depending on their coupon:

• A high-coupon gilt delivers most of its return as taxable interest.
• A low-coupon gilt bought below face value delivers much of its return as a price gain from the discount pulling toward par at maturity — and that portion is free of CGT.

This is precisely why low-coupon gilts trading below par attract attention from higher-rate taxpayers holding investments outside a tax wrapper. It isn't a loophole; it's long-standing, deliberate treatment.

Two important caveats. First, inside an ISA or pension the distinction largely disappears, because those wrappers already shelter income and gains (see Tax-Efficient Investing). Second, tax rules change, and how any of this applies depends entirely on your own circumstances — this is an explanation of how the treatment works, not a recommendation to act on it. Check the current rules and consider professional advice.

The Risk Nobody Expected: 2022

Gilts carry negligible credit risk. What 2022 demonstrated, brutally, is that they carry very real interest-rate risk.

Following a period of rising rates and a fiscal announcement that unsettled markets, gilt yields rose sharply and suddenly. Because long-dated bonds have high duration, their prices fell steeply — long gilts lost value on a scale most people associate with equities, not government debt.

The damage spread through an unexpected channel. Many UK pension schemes ran liability-driven investment (LDI) strategies, using leveraged gilt positions to match their long-term obligations. As gilt prices collapsed, those positions triggered collateral calls, forcing schemes to sell gilts to raise cash — which pushed prices lower still, triggering more calls. The Bank of England intervened with emergency gilt purchases to break the spiral.

The lesson is the one that runs through all of fixed income: "safe" refers to getting your money back, not to the price staying still along the way. A 30-year gilt held to maturity does what it promised. The same gilt sold after a sharp yield rise can crystallise a severe loss. Duration is the risk that matters in government bonds.

How Individuals Access Gilts

Broadly three routes, each with different practical implications:

• Directly through a broker, buying individual gilts on the secondary market and choosing your own maturity and coupon.
• Through gilt funds or ETFs, which hold a basket across maturities. Convenient and diversified, but note a fund is continuously rolling its holdings rather than maturing — so you never get the certainty of a specific repayment date.
• At issue, via the government's purchase and sale arrangements for private investors.

The choice between an individual gilt and a gilt fund is more consequential than it looks: holding a single gilt to maturity gives you a known outcome, whereas a fund's value simply floats with the market indefinitely.

Common Misconceptions

"Gilts are risk-free." They're as close to free of credit risk as sterling investments get. They are not free of interest-rate risk — as 2022 proved — nor of inflation risk if conventional.

"Index-linked gilts can't lose money." They protect against inflation, but their prices still move with real yields. A linker can fall in value even while inflation is running high.

"The Bank of England sets gilt yields." It sets the base rate, which strongly influences short-dated gilts. Longer-dated yields are set by the market's expectations for inflation and growth — which is why long gilts can rise even as the Bank cuts.

"Gilts are entirely tax-free." Only the capital gain is exempt from CGT for individuals. The coupon is taxable as income.

Real-World Application

Consider two investors, both holding gilts outside any wrapper, and both wanting a known sum in five years.

The first buys a conventional gilt maturing in five years. Their outcome is fixed in cash terms: they know the coupons and the repayment. If inflation then runs unexpectedly hot, they still receive exactly what was promised — but it buys less than they hoped. Their risk was never default; it was inflation.

The second buys an index-linked gilt. Their coupons and principal rise with inflation, so their purchasing power is protected — but if inflation comes in lower than the market expected, they'll end up worse off than the conventional buyer, because they effectively paid for protection they didn't need.

Neither is right or wrong. They are different bets on inflation, dressed in the same government guarantee. And layered on top, a higher-rate taxpayer would notice that a low-coupon conventional gilt returns much of its gain free of CGT, while a high-coupon one hands more of it over as taxable interest — the same maturity, a materially different after-tax result. That interaction between structure and tax is what makes gilts a genuinely British corner of investing, and why they're worth understanding on their own terms rather than as "just bonds".

Key Takeaways

• A gilt is a UK government bond, issued by the Debt Management Office; the name comes from gilt-edged securities.
• Three types: conventional (fixed cash), index-linked (inflation-protected purchasing power), and green (conventional terms, environmental spending).
• Price and yield move inversely; the 10-year gilt is the UK's benchmark long-term borrowing cost, feeding into mortgages and valuations.
• Distinctive tax treatment: price gains are exempt from CGT for individuals while the coupon is taxable as income — so a gilt's coupon level materially changes its after-tax return. Rules change; seek advice.
• Gilts carry negligible credit risk but real duration risk — the 2022 episode showed how sharply long-dated gilts can fall and how that can destabilise leveraged holders.