BoE rates: Yield challenge for pension funds

10 May 2018

Forecasts for bond yields in the UK have dropped, as the Bank of England (BoE) confirmed that bank rates will be kept at 0.5% this month.

At its meeting, the bank’s monetary policy committee voted 7-2 against a rate hike and maintain its current levels of corporate and government bond purchases. The monetary policy committee justified its decision with the lower than expected GDP growth rates in the first quarter, as well as the uncertainties of ongoing Brexit negotiations.

At the same time, it clarified that if the economy grew in line with its May inflation report forecasts, it would consider tightening monetary policy. The decision resolves weeks of speculations among investors and analysts, who had initially priced in a rate hike in May. Pricing in the prospect of potentially higher borrowing costs, 10 year gilt yields had recently been over the 1.5% mark.

In anticipation of the BoE decision, HSBC announced earlier today that it has reduced its year-end forecast for 10 year gilts by 30 basis points to 1%.

Yield rises have been beneficial for fixed-income heavy pension funds, which reported a gradual reduction of their deficits at the beginning of May. The yield rises have also boosted the balance of the Pension Protection Fund (PPF), which reported earlier this week that its deficit had dropped by almost a third in April.

Alex Hutton-Mills, managing director at Lincoln Pensions comments: “Today’s decision by the MPC to hold interest rates is not surprising following the release of weaker growth figures for Q1 2017. This will, however, be disappointing for many trustees who have been hoping a rate rise would provide some relief for their pensions scheme’s deficit. Instead, trustees will need to keep a watchful eye on the broader economy and ensure that they have appropriate contingency plans in place for any further funding shocks” he warns.

Commenting on the BoE’s more cautious stance, asset managers now predict that a rate hike may have been put on hold until much later this year, reflecting further downward pressure on bond yields.

“Central banks remain data dependent, but are increasingly intent on hand-holding, providing signals and guidance to the market. What this has meant in recent practice is that both the FOMC and BoE have tended to move rates at meetings which are followed by press conferences, where they can verbally articulate their changes. This is why the market is pricing in a low probability of a move by the BoE in June, but a greater chance of a hike at the quarterly meeting in August. To my mind, even August may prove too soon, if the consumer squeeze and hesitant investment environment continues” says Anjulie Rusius, fund manager at M&G.

Silvia Dall’Angelo, senior economist at Hermes, warns that the opportunity window for further BoE rate hikes might have closed: “Domestically, April surveys on economic activity (the services PMI, notably) pointed to a sluggish rebound from the weather-related weakness in March, suggesting that a more fundamental slowdown might be in place, particularly affecting the consumer. External developments might also play havoc with the outlook as protectionist risks are still brewing in the background. Most importantly, Brexit is still the main source of uncertainty for the economic outlook and related risks have not receded” she stresses.

Annalisa Piazza, senior investment strategist, Cardano warns that investors should continue to consider the risks of  rate hikes:“Some “normalisation” in Bank rates should be expected, albeit at a slow pace. Against this backdrop, trustees need to ensure that they protect their portfolios from rising market rates, albeit at a moderate pace. The potential for volatility in sterling should also be factored into pension funds’ investment and hedging strategies going forward, as currency has been the most significant driver of inflation since the Brexit Referendum” she stresses.


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