Elaine Torry, Co-Head of Investment DB, Hymans Robertson says: “Today’s rate rise from the Bank of England is rightly going to grab the headlines, reflecting the very real impact that it will have on businesses and consumers alike. However for pension scheme trustees it’s a bit of a double edged sword. For schemes less than 100% hedged to interest rates, the more wider rise in yields that is being seen in the market will be a positive, isolation, for funding levels. But the challenge that is almost overshadowing this improvement for many schemes, is the balancing act that is having to be performed between managing risk and sticking to strategy versus the practicalities of fielding collateral calls and maintaining hedging positions.
“With asset allocations for some schemes drifting 5-10% off benchmark, trustees are faced with the decision about running an out of kilter risk profile, selling illiquid assets at potentially 20% haircuts, or accepting interest rate and inflation risk to increase in their portfolios. With tomorrow’s fiscal statement, or mini budget, as the first announcement from the new Chancellor there remains further uncertainty for many. DB Trustees must evaluate whether this interest rate hike, and subsequent knock-on effects, present an ironic opportunity to take advantage of improvements in funding positions or whether running to stand still will continue to dominate time and attention.”
Charlotte Jones, Senior Consultant at XPS Pensions Group, commented: “A rise of at least 0.5% was already anticipated by investment markets, with a c2.7% rise in long-term government bond yields since December 2021 reducing liabilities of UK DB pension schemes by £750bn, nearly 35%.
“Analysis by XPS’s DB:UK funding tracker shows that UK pension schemes are now in surplus, with the improvement in funding positions largely attributable to rising interest rates. The energy cap should lead to prices rising less quickly than previously feared, but with the future far from certain, pension scheme trustees should strongly consider taking measures to lock in some of these gains by reducing levels of risk in their investment strategies or securing members’ benefits with an insurance company”.
Fran Bailey, Partner at LCP, commented: “In this high interest rate environment trustees need to really understand the finances of the sponsoring employer. Engagement is key to this. Processes should be in place to ensure that any changes in a sponsor’s financing profile are communicated in a timely manner, and that sufficient information is shared to allow the covenant impact of these to be assessed. This will help them to protect both the scheme and themselves.”
Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown: ‘’The starting whistle has been blown on the economic tug of war between the Bank of England and Liz Truss’ government. This is a more prudent pull on the on the monetary policy rope than had been widely expected. Even so, as it’s the seventh rise in quick succession, it still shows determination by the Bank to pull inflation down from stubbornly dangerous levels in terms of financial stability. Rates have raced up from 0.1%to 2.25% in less than a year, representing a sharp increase in borrowing costs, on top of the painful rise in energy and food prices.
Policymakers are digging in their heels and will be bracing for the counterattack from the Treasury, with Chancellor Kwasi Kwarteng widely expected to be hanging tight on his resolve to cut taxes to try and stimulate growth, with the mini-budget set to be announced tomorrow. Team Bailey at the Bank of England want to squeeze demand out of the economy, to try and stop the spiral of prices, while Team Truss want to stimulate it, risking prolonging the pace of rate hikes.
The Bank of England’s strategy may be unprecedented, but it’s recently become a well-trodden path, and up ahead the US Federal Reserve is leading the way, having raised rates by 0.75% for the third time in a row yesterday, and signalled there were more robust hikes to come. There may have been some dissent around the table at the Bank of England, about the size of the rate hike, but there is unanimity about the direction of travel, given that inflation is set to peak at 11% in October. The warning is clear - if inflation continues to be persistent, policymakers won’t hesitate to respond much more forcefully.
The pound has been suffering as the dollar has gained more strength amid expectations the Federal Reserve will keep staying ahead of the pack. If the Bank of England relaxes its grip in rate rises, sterling could be dented considerably further, which could see inflation slipping ahead again due to the impact of pricier imports. Already the pound has fallen on the news, back to below $1.13 and the Bank will won’t want this pattern to accelerate further.
Neither side seems inclined to blink first in this face off, with the government more intensely focused on stopping a deeper recession from forming in the months to come. The Bank of England’s forecast that inflation is set to stay at double digits for months to come is unlikely to weaken the Truss administration’s resolve to put growth first.
The energy price freeze has made Threadneedle’s task a little bit easier, as inflation is now not expected to peak at the really scary level of over 20%, but the pressure is still on. Given the shock and awe tactics of other central banks, who appear to be bringing forward planned rate rises for 2023 into the next few months, the Bank of England is also expected to keep pulling tight on the monetary policy rope to try and tug inflation down with forecasts that interest rates may reach anywhere between 3.5% and 4.75%. It’s clear the path ahead is fraught with uncertainty.’’
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