Party A pays a fixed rate
The same rate for the whole life of the swap.
Inside the Yield
Gilt over swap
The gilt's extra yield over the sterling overnight-index swap of the same maturity.
A swap, here, is a sterling overnight-index swap. Two parties exchange interest for a fixed number of years, and nothing else. One pays a fixed rate. The other pays the overnight rate, compounded, as each night prints. In sterling that overnight rate is SONIA, the Bank of England's measure of the rate paid on overnight wholesale deposits. No one hands over a principal. On the day the swap is dealt, the fixed rate is set so the contract is worth nothing to either side. That rate is the swap rate of that maturity. It is the market's price for the average of overnight rates over the life of the contract.
Party B pays SONIA
The overnight wholesale rate, compounded as each night prints.
No principal
Only the difference between the two rates is paid. Margin covers the change in value.
| Gilt | Overnight-index swap | |
|---|---|---|
| What is paid | Cash today. Coupons, and the face value at maturity. | The difference between a fixed rate and compounded SONIA. |
| Principal | The buyer pays it. The government repays it at maturity. | None is exchanged. |
| Claim | On the UK government. | On the bank, or on the clearing house once the swap is cleared. Margin covers the move in value. |
| Balance sheet | The buyer parts with cash, or borrows it. A dealer who holds the bond uses balance sheet until a customer takes it. | Unfunded, apart from that margin. |
| How it is quoted | A price per £100 face, or a yield. | The fixed rate that makes the swap worth nothing on the day it is dealt. |
A gilt is a different contract, as the table sets out. The buyer pays cash now. The government pays the coupons and the face value later. The yield is the rate that sets the price of those payments. This slice is the nominal gilt spot yield minus the sterling overnight-index swap at the same maturity. On 18 September 2026 the gap is about 0.1% at three years, 0.5% at ten years, and 0.7% at twenty-five years. It widens as the maturity lengthens.
The two rates differ because the contracts do not deliver the same thing. The gilt is funded: the buyer parts with cash, or borrows it, and a dealer who takes the bond at auction uses balance sheet until a customer wants it. The swap is unfunded. Only the difference between the fixed rate and the overnight rate is paid, and margin covers the change in the contract's value. A dealer can take a view on the overnight average with a swap without buying the bond. The gilt has to pay for the cash and the balance sheet the swap does not use.
They also differ in what is being supplied. The Debt Management Office sells gilts. There is no matching government supply of swaps. When more bonds have to be placed, the gilt yield rises relative to the swap. A pension scheme can receive a fixed rate on a swap to match a long liability, instead of buying the long gilt. When that bid sits in the swap and the bond is what the market has to hold, the gilt yield sits further above the swap, and that is why the gap is wider at long maturities. A trading desk sometimes calls the short gap liquidity and the extra slope credit. This curve does not separate those names. Issuance, dealer balance sheets and those flows stay one slice.
The swap already prices a path for overnight rates, and the swap curve has a term premium of its own. Subtracting the swap from the gilt takes that overnight-rate price out. What is left is the extra for holding the bond rather than the contract, so this slice is not the whole term premium on Inside the Yield.
The same gap, measured in par yields, is on The UK premium. That page then compares Britain with the United States and the safest euro governments. The gilt-over-swap number here is a spot yield, a few hundredths away from that par gap.