Comment on today’s interest rate rise from the Bank of England
04 Aug 2022
Commenting on today’s interest rate rise from the Bank of England, 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.”