Fiscal spending may make a return
Since the financial crisis, monetary policy has taken the strain of driving economic growth in the UK and across developed markets, while fiscal policy has been constrained.
In the US, we have seen the prospect of fiscal stimulus via tax cuts and infrastructure spending under the incoming Trump-led administration drive US long-term interest rates higher over the past few weeks. Greater use of fiscal policy (if implemented) means that monetary policy need not be as accommodative as would otherwise be the case, potentially leading to rates rising higher and faster than expected.
In the UK, Mr Hammond may also use fiscal policy to stimulate the economy by announcing a multi-billion pound infrastructure boost in the Autumn Statement. This move also has the potential to lead to higher interest rates if it is of sufficient magnitude. However, as we have seen in Japan, fiscal stimulus is not always a guarantee for reviving a slow growth economy. Long-term investors should therefore also consider the possibility of falling as well as rising rates.
Scenario planning for change in the rate cycle
Schemes and trustees should be prepared to cope with all of the potential scenarios around rate movements due to a potential shift towards fiscal policy from monetary policy. Higher rates mean pension schemes should ensure they have a large enough collateral buffer and can rebalance their asset allocation during collateral changes. The question must thus be asked: are schemes prepared for both higher or lower interest rates?
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