Inflation-Linked Bond

With an ordinary bond, inflation reduces the real value of the fixed payments. Inflation-linked bonds adjust their principal in line with an inflation index, and interest is paid as a fixed percentage of the adjusted principal.

For example, an inflation-linked bond with a principal of 1,000 and a real coupon of 1% would, after a year of 3% inflation, have an adjusted principal of 1,030 and pay interest of about 10.30.

Governments issue most inflation-linked bonds. Examples include Treasury Inflation-Protected Securities, or TIPS, in the United States, index-linked gilts in the United Kingdom and similar bonds in the euro area, Canada, Australia and many emerging markets.

The yield on an inflation-linked bond is a real yield, after inflation. Comparing it with the yield on an ordinary government bond of the same maturity gives the market’s implied expectation of inflation, called the breakeven inflation rate. Inflation-linked bonds still lose value if real interest rates rise, as happened sharply in 2022.