David Brooks, technical director at Broadstone: The latest Bank of England (BoE) interest rate rise may well have been expected, but over recent months gilt yields have increased significantly and this could have had a material impact on DB pension schemes’ funding positions, depending on the level of any interest rate hedging that is in place.
All else being equal, schemes that are not fully hedged will have seen their funding positions improve over recent months. While any underhedged position may be proving a positive contributor this is not something for Trustees to be complacent about and should be a position taken consciously.
The statement from the BoE that inflation will reach 10% in Q4 this year, nearly 1.5% higher than the Office for Budget Responsibility (OBR) predicted, will be concerning. However, this may encourage schemes, particularly those that are now better funded, to consider de-risking their positions. At the very least they should be reassessing whether their liability hedging programmes remain in line with their intended targets given the significant moves in both interest rates and inflation.
Trustees and sponsors should also watch carefully the impact of interest rate hikes, both in the UK and elsewhere, on the wider economy as this may yet depress the recovery from the Covid-19 pandemic.
Steven Cameron, Pensions Director at Aegon comments: “In response to soaring inflation, the Bank of England has increased interest rates for the fourth consecutive time to 1%, the highest rate since February 2009 but still very low in historic terms. While this could provide a small boost to cash savers if the rise is passed on to saving accounts, any benefit in purchasing power will be wiped out many times over by rocketing prices, with the most recent inflation figure of 7% at a three-decade high and expected to rise further. Those in cash savings paying 1% interest are losing a huge 6% a year in purchasing power.
“Aegon analysis of inflation and interest rates over the last 50 years shows that people are losing more purchasing power now than at any other time over the last 44 years. You need to go back to November 1977 for as bad a situation, when inflation was at 13%, or 6% above the base rate of 7%.
“When inflation was last as high as it is now, in early 1992, the base rate was sitting at over 10%. That meant cash savers achieving this return were still beating inflation and seeing their purchasing power increase by around 3% a year.
“With inflation likely to remain well above interest rates for the foreseeable future, individuals might consider investing any cash savings they are unlikely to need in the short term. However, investing in stocks and shares comes with risks and can go down in value. It can be worthwhile seeking financial advice.”
Tom Birkin, Actuary at XPS Pensions Group, commented: “Despite the UK currently experiencing the highest levels of inflation for over 30 years, with interest rates rising and long term expectations of inflation now stabilising, pension schemes which are not fully hedged will be better funded than they were at this time last year. Given the cost of living crisis facing pensioners and with caps on pension increases already limiting pension income, pension scheme trustees may come under increasing pressure to pass on some of these funding improvements to their members by providing discretionary increases to members’ pensions above inflation caps.”
Sarah Pennells, Consumer Finance Specialist at Royal London says: “Interest rates have increased for the fourth time in six months with the latest hike taking the base rate to its highest level since 2009, rising by a quarter-point from 0.75% to 1.00%. “Interest rates rose in December for the first time since 2018 and the Bank of England hasn’t paused for breath since, with four successive rises signalling the end of a sustained period of ultra-low rates.
“Savers are being hit with a double whammy. Those who can leave their savings untouched will still lose money in real terms, despite today’s rate rise, because the return on cash held in savings is significantly below the current high level of inflation. The rise in the cost of living, outpacing the rise in wages, is also forcing others to dip into their savings, with a quarter (24%) of full time workers in the UK looking to access some or all of their short term savings to help them get by day to day. “A fall in disposable income also means we’re spending more and saving less. As costs continue to rise, it’s turning on its head the situation created during the pandemic where millions became ‘accidental savers’ to a situation where inflation is forcing us to become ‘accidental spenders’.
“Alongside interest rates, sharp rises in household bills and the general cost of living is a huge concern for 95% of adults in the UK, leaving many wondering how they’ll make ends meet. Worryingly, a fifth (21%) of people plan to borrow their way out of trouble, at a time when the cost of borrowing is escalating. “Mortgage borrowers on a variable rate have barely had time to deal with the effects of the last rate rise and are now faced with a further increase. Every quarter per cent rise in mortgage rates costs someone with a £200,000 25-year repayment mortgage an extra £27 a month. While some homeowners will be able to afford that, others will undoubtedly struggle, especially as other costs spiral.”
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