PATRICK TOOHER explains what a bond is and why politicians fear debt markets more than any other

What is a bond?

A bond is a debt or loan issued by an investor to a government or company that must be repaid in full at a specified date in the future.

In addition, the investor receives a fixed interest on the loan during the term.

What are bonds used for?

The government issues bonds, also called government bonds, to close the gap between government spending and tax revenues.

If interest rates are fixed, why do bond yields go up and down?

Bonds are traded between investors, who make judgments about the government’s creditworthiness.

The riskier they see the bet, the higher the price (or return) they demand.

So higher bond yields are a bad thing?

In general, yes. Higher bond yields increase the cost of government borrowing.

In other words, interest rates on debt rise, consuming money that could be spent on public services such as schools, hospitals, welfare and defense.

Do bond prices affect mortgage rates?

Yes. Banks and building societies price their home loans with a fixed interest rate – the most popular type of mortgage – at the bond rate.

It means that borrowers face higher interest payments if, for example, they want to extend their fixed-rate mortgage agreement for two or five years.

Tracker mortgages move in line with Bank of England interest rates and are not directly affected by bond yields.

What does it mean for savers?

Bond prices reflect a number of factors, including interest rate expectations.

So if bond yields rise, it means investors think rates could go up – or at least stay higher for longer, as is the case now – which is good news for savers.

What about the pound in my pocket?

Higher interest rates should mean a stronger pound, which would be good news if you’re heading abroad.

But sterling has weakened against the dollar recently on fears that US inflation will rise under President Donald Trump, keeping US borrowing costs high.

Are there other winners and losers?

Yes. Higher bond yields are bad news for those in a ‘lifestyle’ workplace pension scheme, causing members to move from shares to supposedly ‘safer’ bonds as they approach retirement.

That’s because bonds, which promise to pay the holder a fixed income if held to maturity, fall in price as their yield rises.

The downside is that annuity rates, which guarantee retirement income, become more valuable as bond yields rise.

In other words, you can buy the same annuity for less – or more income for the same expenses.