Index-linked gilt, inflation uplift

aroominyork

SnowMan said:

aroominyork said:

The one year situation makes sense. What confuses me is the more recent price movement. I bought T29 on 15 August 2025: 25,684.85 units for a total cost of £42,700. The dirty price today is £167.445 giving a value of £43,008, an increase of 0.72% over three months. Over the last three months, nominal TG29 has increased 1.2%. What accounts for the difference; was it a reduced expectation forecast during mid-October? And equally, what accounts for the increase on ILG price at the left-hand side of the chart? The basic question is whether anything other than changing inflation expectations accounts for variances in price movements between nominal and index-linked gilts that have similar maturity dates? (I realise the chart shows clean prices, but I think it demonstates the general point...?)

The mid dirty closing price of T29 on 14th August was 165.981 and the mid dirty closing price at close on 15th August was 165.8523. The closing mid dirty price at 18th November was 167.4881. Using the 15th figure that's a return of 0.99% (= 167.4881/165.8523 - 1) over the period. Add in the coupon (no coupon was paid on the conventional gilt in this period) that takes you up to about 1.06% return. So that is quite close to the conventional gilt. And the difference could no doubt be explained by things like the implied inflation changing slightly over the period, and the actual inflation uplift over the 3 months etc etc. 

If you paid 42,700 for 25,684.85 nominal that is equivalent to a dirty price of 166.25 (= 42,700/25684.45) so perhaps the price increased on 15th November until you bought it and and then fell back at close.

When you are trying to explain very small differences like this you have to be precise in comparing like with like.  

aroominyork said:

I expected them to move out of synch when there is an actual unexpected change in inflation for the previous period, or change in projected inflation for the future period to maturity. What we see here is a shift of about 1.4% between early September and early November. Does that suggest a sudden expectation of inflation increasing by about 0.4%pa less than previously expected in the period to maturity (early 2029)?

I'm just trying to work out whether the bold bit in your helpful answer is essentially saying the same as I wrote about why they move out of synch?

leosayer

The reason behind any stock or bond price change or disparity is driven by trading activity and whilst there are obvious drivers such as those mentioned in this thread, there can be others that have nothing to do with the obvious such as (off the top of my head)...

...changing actuarial factors or methodology on pension funds causing increased buys or sells
...exchange rate movements and/or inflation predictions in other countries making UK gilts more or less attractive
...hedge funds spotting an arbitrage opportunity

SnowMan

aroominyork said:

SnowMan said:

aroominyork said:

The one year situation makes sense. What confuses me is the more recent price movement. I bought T29 on 15 August 2025: 25,684.85 units for a total cost of £42,700. The dirty price today is £167.445 giving a value of £43,008, an increase of 0.72% over three months. Over the last three months, nominal TG29 has increased 1.2%. What accounts for the difference; was it a reduced expectation forecast during mid-October? And equally, what accounts for the increase on ILG price at the left-hand side of the chart? The basic question is whether anything other than changing inflation expectations accounts for variances in price movements between nominal and index-linked gilts that have similar maturity dates? (I realise the chart shows clean prices, but I think it demonstates the general point...?)

The mid dirty closing price of T29 on 14th August was 165.981 and the mid dirty closing price at close on 15th August was 165.8523. The closing mid dirty price at 18th November was 167.4881. Using the 15th figure that's a return of 0.99% (= 167.4881/165.8523 - 1) over the period. Add in the coupon (no coupon was paid on the conventional gilt in this period) that takes you up to about 1.06% return. So that is quite close to the conventional gilt. And the difference could no doubt be explained by things like the implied inflation changing slightly over the period, and the actual inflation uplift over the 3 months etc etc. 

If you paid 42,700 for 25,684.85 nominal that is equivalent to a dirty price of 166.25 (= 42,700/25684.45) so perhaps the price increased on 15th November until you bought it and and then fell back at close.

When you are trying to explain very small differences like this you have to be precise in comparing like with like.  

aroominyork said:

I expected them to move out of synch when there is an actual unexpected change in inflation for the previous period, or change in projected inflation for the future period to maturity. What we see here is a shift of about 1.4% between early September and early November. Does that suggest a sudden expectation of inflation increasing by about 0.4%pa less than previously expected in the period to maturity (early 2029)?

I'm just trying to work out whether the bold bit in your helpful answer is essentially saying the same as I wrote about why they move out of synch?

They are essentially the same.

If we assume that the market at time of purchase believes that inflation will be a constant 3%pa over the term to maturity they will price an index linked gilt and equivalent term conventional gilt consistently with that. 

If inflation is then exactly 3% throughout the term then the proceeds at maturity from the index linked gilt will be equal to the proceeds from the conventional gilt. 

If we are assessing things a year after purchase and inflation has been 4% (or 2%) over that year but then reverts back to 3%pa for the remainder of the term then the maturity proceeds from the index linked gilt will be 1% (=4% - 3%) higher or 1% lower (= 3% - 2%) respectively than the maturity proceeds from the conventional gilt. 

If we are assessing things a year after purchase and inflation has been 3% as expected over that year but then increases to a constant 4.5%pa for the remainder of the term (lets say that's 4 years) the proceeds from the index linked gilt will be about 6% higher (= 1.5% x 4 years) than the maturity proceeds from the conventional gilt.

And if we are assessing things a year after purchase and inflation has been 3% as expected over that year but then reduces to a constant 1.5%pa for the remainder of the term (lets say that's 4 years) the proceeds from the index linked gilt will be about 6% lower than the maturity proceeds from the conventional gilt.

That is oversimplifying and of course amongst many other things nominal and real interest rates vary over time and other factors influence pricing. But that's the basic idea.

In deciding whether to invest in a conventional gilt or index linked gilt of similar term the first thing to consider is what is the purpose of the investment. If it is to cover future expenditure which is likely to be inflation linked then the obvious preference would be the index linked gilt. While the conventional gilt may provide better returns if inflation is below expectations, it doesn't provide the matching cashflows needed to cover future expenditure that the index linked gilt provides and that matters should inflation get out of control. 

It is also important that the term of the gilt is consistent with when money is required to cover the future expenditure.