Investor Insights: Rally in UK bonds may be set to continue in 2026 – is it time to own more gilts?

UK markets have enjoyed a strong period of late, with the FTSE 100 up 33% since last April’s tariff-induced lows and gathering momentum to hit 10,000 for the first time at the start of 2026. 

But while stocks grab all the headlines, gilts have also quietly been doing rather well.

Following a rough summer ahead of the Budget and a global bond selloff, 10yr gilt yields – which move inversely to the price – have declined from around 4.8% at the highs last September to around 4.4% today. 

Usually much of the move in gilts is related to global trends. But since the start of this year gilt yields have declined modestly while US Treasury yields have risen, resulting in a narrowing of the spread between the two countries’ debt costs. This may reflect some more confidence in the UK policymaking process versus the apparently erratic economic policy of the US administration, although it’s a bit more complicated than that. Japanese bond yields have soared this year, which has caused ripples across the world, yet still gilt yields have fallen.

Trending upwards since September 2024, shorter-dated gilt yields spiked one year ago in January 2025, hitting highs not seen since the 2008 financial crisis. This was related to high inflation, fears about government spending, and rising US yields.

Since then, the yield on gilts maturing in 10 years or less trended down, while longer-maturity yields climbed, peaking in September amid a global bond rout before some more clarity around the Budget started to emerge and the global situation eased. The dynamic was simple enough – the shorter-maturity debt rose as markets priced in interest rate cuts by the Bank of England, while the longer-dated paper fell, pushing up yields, because of worries about how the government would balance the books further in the future – a question of debt sustainability that goes beyond the UK. Inflation expectations also weighed on the longer maturity gilts. 

Why gilts have rallied

• Lower inflation

• Bank of England rate cuts

• Receding risks from fiscal pressures

• DMO shortening maturities

Lower inflation has played a key part in the rally in gilts. One of the reasons for the UK’s higher yields was stickier inflation; it was an outlier in terms of bringing inflation down following the surge in prices during 2022, which saw the CPI rate of inflation peak at 11.1% in October of that year, a 41-year high. And while CPI inflation trended down to a low of 1.7% by September 2024, it started to climb again, raising fears about the ability of the Bank of England to cut rates. Moreover, the UK relies heavily on inflation-linked gilts, which are more sensitive to changes in inflation.

Now, the market is much more confident that inflation is trending lower sustainably and will reach the Bank’s 2% this year, despite the recent rise in December 2025 CPI, which was due to one-off factors like tobacco duty changes and airfares. Markets see the Bank cutting rates twice more this year, but there is a chance it does more. 

Fiscal risks have also receded, which has had a greater impact on the long end of the curve than the short. In the Budget last November, the Chancellor, Rachel Reeves, moved to raise taxes and fiscal headroom eased concerns about debt sustainability and immediate fiscal risks from the so-called bond vigilantes. Question marks over whether she could stay in her job have also receded somewhat. Reeves is seen as the most ‘market-friendly’ possible candidate as Chancellor within the government.

The Debt Management Office has also changed tack. It has shifted to issuing more shorter-term borrowing to lower debt interest costs. Shorter-term gilt yields are considerably lower than their long-term cousins – the spread between the 2yr and 30yr gilts is about 150bps right now. This is partly because of structural demand for long-dated paper falling as pension funds dial back exposure, with defined benefit schemes now largely closed to new members and existing ageing. 

The UK’s average debt maturity has stood at about 14 years versus about 6 for US Treasuries, though it is now coming down. This is due to historic demand from these pension funds that had to match long-term obligations with long-term debt. Moves to further reduce the average debt maturity for UK gilts could further lower borrowing costs across the curve.

Can the run continue? Upside and downside risks for gilts in 2026

Investment banks are bullish on gilts. Morgan Stanley sees the UK 10yr yield declining to 3.9%, while Goldman Sachs predicts 4% and thinks – as do I - the BoE will cut rates three times to take the base rate to 3.0%.

The market is already pricing in 2 interest rate cuts – certainly a third could help push yields even lower at the shorter end of the curve where demand is highest. The risk would be a sharp rise in inflation that changes the BoE’s forecasts and prevents or slows the pace of cuts. 

However, we could see inflation returning to target even sooner than the BoE expects, even as early as the new tax year, as price hikes to water, education and rail fares in 2025 will not be repeated this April.

Political risk is still lurking, even if it has clearly receded since the Budget. Local elections in May could create headline shocks and pile pressure on the Prime Minister, Keir Starmer. Any sense that a leadership change could see the appointment of a less fiscally responsible Chancellor would rattle gilt markets.

A market shock is not of the question. Heightened geopolitical risk – 2026 has already seen a lot – could see investors seek to sell some riskier assets in favour of gilts. This could be particularly relevant to investors with large US equity holdings – and therefore USD exposure – should the dollar continue to come under pressure.

UK growth rates are another consideration – one of the reasons for gilts doing well is the lacklustre growth outlook. An uptick in GDP could be driven by all kinds of factors and would tend to push yields higher. 

Finally, there is a risk of a gilt market shock emanating from leveraged hedge fund trades. The BoE has expressed concern that hedge fund borrowing for gilt trades has jumped tenfold to £100bn in just a year. Officials are worried that a sudden economic or financial shock could trigger “fire sales” of UK bonds.

Why gilts? Retail appetite for gilts is growing

Gilts are becoming more popular among retail investors for a number of reasons. This seems to be true across the curve though traditionally the market for retail investors has been concentrated in the ultra-short end. For reference ultra-short: less than 3 years, short: 3–7 years, medium: 7–20 years, and long: greater than 20 years.

Retail demand has tended to increase more during periods when gilt yields have risen relative to cash savings accounts, according to the Bank of England. In 2022, gilt yields moved higher as the central bank raised interest rates, coinciding with an increase in retail positioning. Investors have been keen to lock in higher yields using gilts.

More recently, growth in demand has slowed as short-maturity gilt yields have moved marginally lower throughout 2025, despite the fact that rates remain high relative to pre-2022 levels.

Second, it's just easier than it used to be. The BoE notes on its Bank Underground blog how the “evolution of digital investment platforms and an increase in educational material from retail-focused firms have accelerated retail demand”, noting “retail-friendly features, like real-time pricing and integration with Individual Savings Accounts (ISAs)”.

A need for greater diversification and to reduce some risk exposure is another factor as investors reacted to market volatility. Holding a gilt to maturity means short-term price swings don’t matter as you can rely on the UK government – which has never defaulted on its debt – returning the par value on maturity. 

Tax efficiency is key consideration

Investors are also using gilts to be more tax efficient, focusing attention on ultra-short-dated lower-coupon bonds. This makes sense for a number of reasons, not least the fact that it means investors are far less sensitive to rates and yield fluctuations.

Capital gains on gilts are exempt from taxation, while coupon payments (interest) is taxed as income.

Therefore, many investors look at low-coupon gilts that generate most of their return through the capital appreciation as they approach maturity. These pay a lower rate of fixed interest, but as the bond moves closer to its maturity date its price moves up towards its nominal value. 

In effect this results in a higher after-tax yield for compared to higher-coupon gilts.

The effect is bigger in a higher yield environment when lower-coupon gilts are trading at a lower value, increasing the capital gain at maturity.

ISA benefits

Therefore, in a lower yield environment where the effect is less pronounced, it makes sense that investors are looking at higher coupons once again, particularly if they can include these within an ISA tax wrapper since holding gilts within the ISA tax-free wrapper offers complete tax exemption on both interest and capital gains.

Indeed, retail holdings of middle and high-coupon gilts have risen over the past three years, says the BoE, which could be down in part to the income tax exemption gained from holding gilts in an ISA or SIPP.

Investors holding the UK 0.125% 30 January 2026 gilt

Gilts with short or ultra-short maturity expiring soon are usually the most popular as they offer the closest to a fixed-rate saver you might get with a bank.  

Investors who have bought the low coupon gilt that matures on 30 January 2026 will need to make a decision soon on what to do next with the investment, whether they choose to sell the gilt before it matures or wait for the lump sum payment.

Available low-coupon, short-maturity gilts include the United Kingdom 0.125% 31 Jan 2028, which trades at about £93.58 and matures in two years. Another is the United Kingdom 0.25% 31 Jan 2031, currently trading just short of £82, with five years to maturity.

If you want to higher coupon within an ISA tax wrapper rather than capital appreciation the United Kingdom 4.125% 29 Jan 2027 currently trades slight above par at £100.44.