Chris Arcari, Head of Capital Markets, Hymans Robertson says: “Since the last Monetary Policy Committee Meeting in early November, pressure on the Bank of England to maintain market confidence has abated somewhat and, while further rate rises are priced, the extent of further rises expected has fallen dramatically compared to those seen in the wake of the now infamous “mini” budget.
“The market is pricing with near-certainty a 0.5% p.a. rate increase on Thursday, a step down from the recent 0.75% p.a. increase, with rates expected to peak around 4.7% p.a. next summer. Despite recent growth outturns surprising to the upside, tentative signs of weakening labour demand and likely near-term economic weakness probably provides major central banks just enough justification to ease the pace of rate increases. However, wage growth remains strong, with average weekly earnings rising 6.1% year-on-year in October, and the Bank of England are likely to err on the side of caution with stickier core inflation likely making the MPC less likely to start cutting rates towards the end of next year than the market expects, even if economic output is faltering. Put another way, rates may peak at a lower level than markets expect, but may stay there for longer.”
Ian Burns, Principal and Actuary at Buck: “Today’s rise brings the Bank of England base rate to 3.5%, as the Bank continues to battle UK inflation. This is another reminder of just how much change the UK economy has undergone in the last year. In December 2021 the base rate was just 0.1% and CPIH inflation was at 4.8%. This volatility has been immensely challenging but has also opened up a number of opportunities for schemes.
“Trustees have worked hard this year to adapt their investment strategy and accommodate the new and changing market conditions. The rate of change has forced schemes to react quickly and has rewarded those with proactive trustees and well-thought-out contingency plans. Market shocks, like the LDI crisis triggered by the mini Budget, tested schemes’ operational governance and has forced schemes to reevaluate their positions. Funding levels have improved almost across the board and many schemes have used the last year to take advantage of tactical investing opportunities and strengthen their hand. As a result, many schemes will enter 2023 in a very different state from how they began the previous year.
“Despite this, there are some reasons for concern next year. Poor economic growth forecasts mean that 2023 could be a tricky year for some scheme sponsors. Similarly, rising inflation has caused a cost-of-living crisis for scheme members, eroding their purchasing power. This is a particular worry for those who are about to retire and current retirees, who don’t have the luxury of long time horizons to improve their positions.
“Many scheme trustees have shown throughout this year that they are alert to this danger and are ready to make use of appropriate contingency plans. As they continue to evaluate their investment strategy and plan for the new year it’s also vital that they communicate clearly with their members, to explain their plans and address any concerns.”
Steve Hodder, Partner at LCP, said: “As expected, the Bank of England had increased short term rates by a further 0.5%. This takes the base rate to levels not seen since 2008, and now 7x average rate levels seen over the past decade.
“However, this is a lower increase than the 0.75% in November, partly in response to tentative but encouraging signs that inflation is levelling off.
“Interestingly, whilst short term rates continue to go up, the gilt market’s view of longer term rates has continued to come down following the very high levels we saw after the mini-Budget. This seems to reflect a growing confidence that the Bank of England and government will indeed be able to get on top of inflation, and perhaps also a view that with the UK heading for recession rates will need to be cut to support the economy. It is these long term rates that matters most for pension scheme funding, investment strategies and transfer values.”
Charlotte Jones, Senior Consultant at XPS Pensions Group, commented: “Whilst the spike in short-term interest rates is causing major challenges for the UK economy, analysis by XPS’s DB:UK funding tracker shows that the average UK defined benefit pension scheme remains in surplus, with rising gilt yields having removed over £700bn from liabilities over 2022.”
“Higher interest rates are likely to have an impact on defined contribution pension scheme members in terms of return on pension savings. However, the overall effect will vary depending on their investment choices, how much this rise has been priced into markets already and how members plan to take their benefits in retirement. Also of concern is how higher interest rates impact the continued cost of living crisis and whether this will push employees to stop contributing to workplace pension schemes. Whilst research suggests that pension savers haven’t so far reduced or stopped their pension contributions, with some employees only able to change their contributions a certain number of times a year, we may see this trend change in 2023.”
Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown: “The Bank of England has unwrapped another unwelcome present of an interest rate rise just ten days before Christmas, inflicting fresh cost-of-living pain on borrowers. It means the chill descending on the UK economy is set to turn into a much colder snap, with the latest hike in interest rates, freezing off growth further in a bid to cool inflation, which is still at the steaming rate of 10.7%. This is the ninth consecutive rate rise since December last year and the last time the rate stood above 3% was in October and early November of 2008, as the effects of the financial crisis were taking hold and the Bank was in the process of rapidly reducing rates to help the economy.
This inflation is seen as the much bigger Grinch for the UK, threatening to wipe out incomes in an aggressive price spiral which is why the Bank is trying to squeeze out demand despite the economic pain which will be inflicted. The significant price inflation in services and wage growth in the private sector are both red flagged as risks and although the economy is weakening, with a contraction of 0.1% expected for the last quarter of the year, it’s more resilient than had been expected.
Although supply chain snarl ups have also eased, there are fresh worries about the situation with Covid rules and infections in China and there are still concerns about output which could derail supplies again, pushing up prices. The uncertain outlook and wavering price pressures meant the vote was not unanimous, with two policymakers keen for rates to remain at 3% and one outlier calling for a more aggressive 0.75% rise to 3.75%.
The rate rise means millions more households will be dealing with more precarious finances next year, with this latest rate rise set to cause another wobble, particularly for those paying off credit cards, on variable mortgage deals or those wanting to find a new fixed rate offer. The Bank has already flagged in its financial stability report that four million households are to have more expensive mortgages next year and two million will have higher payments by the end of 2025. However, there are glimmers of better news now being glimpsed by investors.
The predicted peak in UK interest rates has fallen back now, coming in a few notches above 4.5% by August 2023. This is a reflection of faster than expected easing of inflation and the return of financial stability, with Jeremy Hunt becoming the new chancellor, after the volatility experienced in September.
The strengthening pound also has economic advantages, including to reduce import inflation, which could lead to price pressures that are not as bad as some expect as we move through 2023. The pound has fallen back a little further against the dollar since the Bank of England’s announcement, and is hovering around $1.23. It had already dipped back due to expectations that higher rates in the US may linger for longer while UK rates might not go as high as previously expected as recessionary cold front moves in.’’
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