The yield curve is a shorthand way to refer to a graph that plots interest rates on the vertical axis against the maturity of bonds or time on the horizontal axis. You can see the yield curves produced by the Bank of England here.
It’s a crucial tool that helps investors, economists, and policymakers gauge economic expectations and market conditions. It reflects economic data and interest rates as well as investors’ expectations about the direction of the economy overall.
A “normal” yield curve slopes upwards, indicating that longer duration bonds will attract higher interest rates. This is the shape of a yield curve in normal economic conditions and reflects an expectation that inflation and risk may rise over time.
When the yield curve inverts and slopes downwards, that means that short-term interest rates will be higher than long-term rates. This is often viewed as a predictor of a recession. It suggests that investors are uncertain about the economic outlook and expect, over time, that rates will fall in order to stimulate growth.
A flat yield curve means that short and long-term rates are very close. Typically a yield curve flattens when there is uncertainty in the economy or the economy is shifting from a period of growth to a period of recession.
The yield curve is a dynamic tool that reflects constantly changing perceptions and behaviours in the market as well as reactions to fiscal and monetary policy changes.
Investors may look at the yield curve to understand market sentiment and evaluate decisions about bond and equity investments.
Central bankers analyse the yield curve to inform their decisions about the base rate and monetary policy. They can use the yield curve to forecast economic conditions like growth and inflation.