This is a financial promotion by Retail Book Limited (FRN 994238). Values can fall as well as rise. This information is not investment advice. It is intended for UK retail investors.
Have you ever wondered why some savings accounts pay more interest than others? Or why a five-year loan usually costs more than a one-year loan? The answer lies in something called the yield curve. It’s a simple idea that can tell you a lot about the economy and your investments.
What Is the Yield Curve?
The yield curve is a graph. It shows the relationship between interest rates (also called “yields”) of bonds of equal credit quality across different maturities. Imagine lining up a series of government bonds, from those that last just a few months to those that last many years. The yield curve connects the dots between the interest rates for each of these bonds.
The Normal Yield Curve
Most of the time, the yield curve slopes upwards. This means that bonds with longer maturities pay higher interest rates than those with shorter maturities. Why? Investors want to be paid more for locking up their money for a longer time. There’s more uncertainty about what might happen in five or ten years than in just one.
When the Curve Changes Shape
Sometimes, the yield curve flattens. This means the difference between short-term and long-term interest rates gets smaller. Occasionally, the curve even inverts and short-term rates become higher than long-term rates. This is unusual and often gets a lot of attention. An inverted yield curve has sometimes signalled that a recession could be on the way.
What Influences the Yield Curve?
The shape of the yield curve is influenced by many factors, including:
- Expectations about inflation: If investors think the economy will grow strongly, they may expect higher inflation and interest rates in the future, which pushes up long-term yields.
- Central bank policy: Interest rates set by the central bank affect short-term yields directly.
- Economic confidence: If investors are worried about a slowdown, long-term yields may fall.
Next Steps
Why Should You Care About the Yield Curve?
Economic indicator: The yield curve can help you understand what’s happening in the economy. If the curve is steep, it suggests investors expect growth and possibly higher inflation. If it’s flat or inverted, it may signal caution or concern about economic prospects.
Investment decisions: The yield curve can affect your investments. If you’re thinking about buying bonds, the curve can help you decide whether to choose short-term or long-term options. A steep curve might make long-term bonds with higher associated yields more attractive. A flat curve could mean there’s little extra reward for taking on more risk.
In short, the yield curve is a simple tool with a big impact. It’s worth keeping an eye on, whether you’re saving, investing, or just curious about the economy.
Important Risks to Consider
The market value of longer-maturity bonds can fall materially if interest rates rise; selling before maturity may return less than you invest (capital at risk). Inflation can reduce real returns; credit events can affect non-government issuers.
This is a financial promotion prepared and communicated by Retail Book Limited. It is provided for general information only and is not intended to be investment advice. Investment values can go down as well as up, and you may get back less than you invest. Past performance is not a reliable indicator of future results.
Retail Book Limited (“RetailBook”), a limited company registered in England and Wales (company no. 14087330) with its registered office at 10 Queen Street Place, London, United Kingdom, EC4R 1AG. RetailBook is authorised and regulated by the Financial Conduct Authority (FRN 994238).
