Fixed income investing

Fixed income – review Q2 2026

At the start of 2026, it was widely expected that UK interest rates would be lowered during the course of the year. However, amid the conflict in the Middle East, the consensus view is that the base rate will remain at 3.75% for the foreseeable future.

Increases in oil and gas prices mean inflation potentially edges higher, which puts central bankers in an uncomfortable position.

The Bank of England have opted to keep rates on hold. Its latest June interest rate decision saw the nine-person strong Monetary Policy Committee (MPC) vote by a majority of 7 to 2 to maintain the Bank Rate at 3.75%. The dissenters preferred a 0.25 percentage point increase to 4%.

Across the pond, the US Federal Reserve last month held rates (3.5% to 3.75%). As things stand, the recent consensus is that US policymakers will keep holding rates in 2026.

However, the European Central Bank bucked the trend by increasing interest rates in June, from 2% to 2.25%. This is the first rate rise in 2023 in response to concerns over higher inflation.

Interest rates have a huge impact on all manner of investments, but in particular bonds. Bond prices and bond yields have an inverse relationship, so if bond prices go down then yields go up, and vice versa.

Longer maturity bonds are more sensitive to interest rate changes. Therefore their prices rise more when interest rates fall, but their prices also drop more when rates rise. The sensitivity to interest rates is known as “duration”.

Against this backdrop, global bond markets slightly rose during the second quarter in sterling terms, with the Bloomberg Global Aggregate up 0.22%.

UK gilts gained 1.99% during the quarter, which in turn led to a decline in gilt yields. This rise marked a rebound from the first quarter, which saw UK gilts decline by 1.85%.

However, UK gilt yields are high versus history, with 10-year gilts yielding around 4.75% at the end of the second quarter.

Gilts are particularly impacted by events in the Middle East given the implications of the UK’s substantial dependency on external energy imports.

The big concern worrying many professional investors is the prospect of stagflation, which occurs when a country experiences slow economic growth at the same time as high inflation. Its last prolonged appearance was in the 1970s.

Stagflation is a difficult environment for bond investors as inflation weakens the real value of coupon and principal payments, while weaker growth means central banks are unable to intervene by reducing interest rates.

Against this backdrop, index-linked bonds and, specifically for UK investors, inflation-linked gilts re-emerge as a portfolio consideration. This gilt type offers a potential hedge against inflation risk as the balance of risks shifts back towards inflation uncertainty rather than a straightforward continuation of disinflation.

Bear in mind that index-link gilts have a high duration, meaning such bonds are more sensitive to changes in interest rates.

For example, in 2022, when interest rates and yields rose to tackle rapid inflation, the negative price effects on more rate-sensitive, higher-duration inflation-linked gilts offset the uplifts associated with the inflation-linking mechanism.

Therefore, selection can be key. The duration of the FTSE Actuaries UK Index-Linked Gilts All Stocks Index being 13.7 years versus 7.5 years for the FTSE Actuaries UK Conventional Gilts All Stocks Index.

Source: Morningstar as of 30 June 2026. Total Returns in GBP - global indices hedged to GBP. Global Aggregate: Bloomberg Global Aggregate, Global Government: Bloomberg Global Treasury, UK Gilts: FTSE Act UK Conventional Gilts All Stocks. Global Corporate: Bloomberg Global Corporate, Sterling Corporate: Bloomberg Sterling Non-Gilt, Euro Corporate: Markit iBoxx EUR, Emerging Markets Hard-Currency: Bloomberg EM Hard Currency Agg, Global High Yield: Bloomberg Global High Yield, Global Inflation Linked: Bloomberg Global Inflation Linked, UK Inflation Linked: Bloomberg Global Inflation Linked UK.

What is fixed income? 

Fixed income is just another term for 'bonds'. The term 'fixed income' refers to the regular fixed interest payment – which is also known as the coupon – that an investor receives for loaning money to a company or a government. 

A bond or fixed income investor also receives the sum they loaned to the company or government when the loan matures, so long as the issuer is not in serious financial difficulty.

Learn more about income investing as an investment strategy. 

Benefits of fixed income investing 

Owning fixed income investments within a portfolio has many benefits. First, the fixed coupon payments add a degree of stability to returns, compared with stocks whose dividend payments are more volatile and dependent on economic conditions. Generating a steady return is important for investors wanting to build a balanced portfolio. 

The other key benefit of bonds is that because they are viewed as safer investments than stocks and shares, they tend to increase in value when events unsettle the stock market and worry investors.  

This is one of the reasons that a so-called 60/40 portfolio of shares to bonds – that is 60% in shares and 40% in bonds – is typically less volatile than investing 100% of your portfolio in shares.

Beware though – it doesn’t always work out like this. In 2022, bonds fell at the same time as shares because of an unusual occurrence where interest rates were increased to control inflation despite a slowdown in economic growth.

Disadvantages of fixed income investing 

The biggest risk when investing in bonds is interest rate risk. When rates go up, it means that investors can get a better deal from newly issued bonds. They therefore sell old bonds and lock in a better rate from new bonds. 

When rates go down, this has the opposite effect. The old bonds that have higher interest rates become relatively more valuable.  

Another factor to watch is economic growth and the possibility that companies cannot pay back the interest on their bonds. While there is next to no chance that safe governments will stop paying interest, and very little chance that blue-chip firms will default on their debt, even during a recession, the same is not true for the riskier end of the bond market, so-called high yield or junk bonds.  

Inflation is also a consideration. Because bonds pay a fixed income, the real value of that income is eroded more when inflation is high.  

This is bad news for bondholders as, unlike with stocks and shares, any benefits of inflation, such as higher profits, is not felt by bond investors.

How to invest in fixed income

Investors can buy bonds directly through an investment platform, like ii. Active and passive bond funds, including exchange-traded funds, are available to buy on the ii platform. You can also buy individual bonds.

UK and US government bonds are popular options, as well as those issued by large companies, such as the Co-Op or Tesco. 

Bonds issued for retail investors are normally priced at £100, rather than in larger blocks aimed at professional investors.

However, picking your own bonds is complicated, and requires a good understanding of interest rates and assessment of a company or government’s finances.

A simpler option is to buy a fund which owns a basket of bonds that either track a bond index or are picked by a professional fund manager.

There is a wide range of bond sectors. Generally, higher risk funds offer the highest yields, but bond prices are most likely to fall when investors are worried.  

The riskier category includes “high yield” corporate funds, as well as emerging market debt funds.  Lower risk funds could be developed government bond funds or investment grade corporate government bond, as there is a very low chance that these borrowers will default on their debt. 

Strategic bond funds are also popular. Here, a fund manager can invest in any type of bond whereas other bond funds are restricted to a certain part of the bond market.   

For investors simply looking for the diversification and income benefits of bonds, and who are not bothered about trying to beat the market, then buying a passive index could be the best option.