The pound has risen against the dollar since at low reached in July 2016, immediately after Britain voted to leave the European Union, when the currency hit a 31 year low against the dollar, when £1 bought just $1.05.
Today (19 January) sterling buys $1.39. The pound has risen less remarkably against the euro but is still at 1.13 euro now compared to 1.17 euro in July 2016.
A higher pound against other currencies might be expected to boost the investment case for gilts in two ways.
The first is a higher sterling should cause inflation to fall, boosting the real value of the fixed income paid to a bond holder.
The second is a stronger pound should make the income paid on the bond worth more to overseas investors.
The current yield on a UK ten-year government bond is 1.33 per cent. UK inflation in December was 3 per cent.
But Peter Elston, chief investment officer at Seneca Investment Managers said the yield on UK government bonds continues to be negative in real terms, in that the annual income received is lower than the rate of inflation, so the real purchasing power of the income from the bonds is still negative.
He said in a world of improved economic growth, “the only way bond yields can go is up".
When the yield on a bond rises, that means the price is falling, so Mr Elston believes investors who buy gilts will suffer a “permanent loss of capital”.
His scepticism about the investment case for gilts extends to the wider bond market. Mr Elston said with economic expansion happening almost everywhere in the world, previously loose monetary policy involving mechanisms such as quantitative easing is likely to tighten, and that will be bad news for most bonds.
Tighter monetary policy is bad news for bonds for two reasons.
It means bond purchasing by central banks (quantitative easing) will be reduced or end, and that takes a major purchaser of bonds out of the market.
The second way is that tighter monetary policy leads to higher interest rates, so the rate of interest paid on cash deposits rises, and in order to compete with that rate, issuers of new bonds must offer a higher rate of interest to compensate investors for the fact they can get a higher rate of interest from cash.
That pushes the price of bonds already issued downwards, because the yields they offer are less competitive compared to the higher yields offered elsewhere.
Noelle Cazalis, who jointly runs the £107m Rathbone Strategic Bond fund, said she is wary of investing in gilts because of the uncertainty around the Brexit negotiations in 2018.
Simon Evan Cook, multi-asset fund manager at Premier, said it is “very difficult” to find value in bonds right now, and he has kept away from government bonds as a result.
Jonathan Davis, who runs Jonathan Davis Wealth Management in Hertford, said he expects inflation to rise, so is similarly negative on bonds.
David.Thorpe@ft.com
