Steven Cameron, Pensions Director at Aegon, comments: “The Bank of England’s gloves are off as they hike the base rate by 50-basis-points to 1.75%, the biggest rise for 27 years, in its fight against inflation. Currently sitting at a 40-year high of 9.4%, it’s now expected to rise to 13% in Q4 2022.
“Today is the sixth round of consecutive rate rises and will compound the short term financial pain for those borrowing money and paying off debt during this cost-of-living crisis. Aegon’s latest research shows 1 in 5 adults (19%) have increased the amount of money they borrow since the cost of living crisis to cover rising bills, including over a third (36%) of under 35s.
“But rising rates may offer a glimmer of good news to cash savers if the BoE’s hike filters through to interest rates paid on cash savings accounts. But even if earning 1.75% interest on savings, the current inflation rate of 9.4% still means losing over 7% in purchasing power each year.
“Rising interest rates tend to have different impacts by age group, with younger or working age individuals more likely to lose out because of greater debt, but older cohorts potentially gaining as more likely to have larger cash savings. But an extra 0.50% interest on £10,000 savings will provide just £50 a year, hardly making a dent in rocketing energy bills with the autumn energy price cap increase expected to increase average bills by almost £1400 a year.
“With interest rate rises and inflation at their highest levels for decades, and with ongoing stock market volatility, the decisions facing savers, investors and borrowers are particularly complex and many would benefit from seeking advice.”
Jonathan Camfield, Partner at LCP, commented: Whilst much of today’s interest rate hike was no doubt already priced into markets, what will be of more immediate interest to pension schemes is the further increase in inflation outturn that the Bank of England is now expecting – up to 13%. The longer high inflation continues, and the higher it gets, the more challenging it will be for pension schemes to navigate. There are significant implications for funding and investment strategies, strategic journey planning, and various aspects of member benefit calculations, all of which should continue to be actively monitored by trustees and employers, to ensure they don’t get wrong footed in this fast evolving situation.
Tom Birkin, Actuary at XPS Pensions Group, commented: “Following today’s announcement, interest rates have now risen by 1.65% in the last 8 months as the Bank of England continues its response to soaring UK prices. Despite this being the largest increase in a generation, it was largely anticipated by investment markets, with a similar rise in long-term government bond yields reducing liabilities of a typical UK DB pension scheme by over 20% and typical scheme funding levels increasing by 12%* during that time.
“Most commentators are expecting rates to rise to above 2% by the end of the year, 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”.
Ben Farmer, Senior Investment Consultant, Hymans Robertson says: “The prevailing high inflation environment continues to impact institutional investors and their portfolios. Despite more recent falls, long-term bond yields have risen significantly this year as the major global central banks remain steadfastly committed to raising interest rates to combat heightened – and persistent – inflation.
“At this morning’s Bank of England MPC meeting the vote was 8-1 in favour of a 0.5% rise, with one member voting for a 0.25% increase. This is a significant shift from the prior month’s meeting, but had been well signposted and indeed was largely priced into markets. This followed on from the Federal Reserve’s own 0.75% increase to US interest rates last week.
“Longer term gilt yields remain elevated versus short term history, with the 20 year gilt yield up almost 2% in 2022 so far. If the market believes that the Bank of England has inflation under control then we could see a reversal to recent trends, with longer term gilt yields and inflation expectations falling. If, however, the markets believe the interest rate rises currently priced in are insufficient, and that inflation will continue to surprise on the upside, we could see further increases in gilt yields. Such moves would continue to impact pensions schemes, on both sides of the balance sheet.
“Any further rises in gilt yields could see sizeable reductions in liability values. To schemes with lower levels of interest rate hedging this could feed through into material gains in funding level and the potential to lock in funding gains by reducing investment risk, for example by increasing hedging. For those with higher levels of hedging and leveraged LDI solutions further rising yields could pose a different challenge, with the need to meet additional capital calls on hedging portfolios. This could either be done by selling non-hedging assets, or reducing hedging if there is insufficient liquidity in the scheme.
“With the above in mind, trustees should be speaking to their advisors to determine whether the recent market moves present an opportunity to take more investment risk off the table, protecting their members benefits, or whether your scheme would benefit from a review of its hedging solution. If yield reverse and move lower, this could provide a short term reprieve from hedging collateral calls, but will ultimately impact funding levels as liability values increase once more.”
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