November’s interest rate rise will do little to improve pension scheme valuations, but managers should prepare their portfolios following a pessimistic economic outlook by the Bank of England.
The cost of borrowing was hiked by 0.25% to 0.5% on 2 November, the first rise for a decade. Indeed, 10 Downing Street has been home to three prime ministers since rates were last raised in July 2007.
The move was expected after Bank of England governor Mark Carney (pictured) dropped hints to a panel of MPs in October after inflation, spurred on by a weakening pound, exceeded his 2% target to reach 3%.
Better-than-expected economic growth in the third quarter and low unemployment also convinced seven members of the Monetary Policy Committee to vote for an increase in the cost of borrowing.
But when it comes to economic growth, it could be a different story next year. The Bank of England’s analysts expect the UK’s GDP to expand by 1.7% in 2018, lower than its previous 1.9% forecast.
The rate rise will have limited impact on pension scheme liabilities, according to Russell Investments managing director of client strategy David Rae.
“The focus should remain on the risks within the asset portfolio and the risks associated with any potential economic slowdown,” he added.
The governor admitted that further rises are on the horizon to tackle inflation, a result of the UK’s decision to leave the European Union.
A gradual rising rate environment, according to Goldman Sachs Asset Management head of UK and Irish institutional business David Curtis, could prompt pension schemes to reassess their investment approaches.
“We believe that for trustees and their advisers, a period of rising rates puts into sharp focus the need to consider long-term risks of meeting liabilities as well as putting a greater emphasis on taking a dynamic approach to managing growth assets.
“Challenges remain for the economy with possible declining business investment and slower migration flows as a result of Brexit uncertainty – both factors that could weigh on the growth and inflation outlook for the UK,” he added.
“Geographical diversity, therefore – ensuring that schemes’ portfolios are not overly biased towards domestic securities – should be high priority when making allocation choices.”