News analysis: The Bank of England has bolstered expectations of a rate rise by the end of the year, but experts have said while schemes should not overreact, they should consider their position ahead of any changes.
Persistently low interest rates have put pressure on defined benefit pension scheme funding levels over the past year, as low yields on government bonds have driven up the cost of meeting liabilities and pushed deficits higher. Earlier this year, for example, telecoms company BT announced its pension scheme's deficit had reached £7bn due to historically low gilt yields.
Speaking at Lincoln Cathedral last Thursday, BofE governor Mark Carney made measured comments about the prospect of interest rates rising.
He said: “It would not seem unreasonable to me to expect that once normalisation begins, interest rate increases would proceed slowly and rise to a level in the medium term that is perhaps about half as high as historical averages.
"In my view, the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year.”
You need to be ready to move when the market does. Get a trigger set up in advance and pull it when it happens
Hugh Nolan, JLT Employee Benefits
Simeon Willis, principal consultant at consultancy KPMG, said the comments were “not out of alignment with what the market expected”.
Willis added: “He talked about getting back toward half of the long-term average. He may have a number in his head, but he didn’t share it.”
Despite the lack of specifics in Carney’s comments, Willis and others said the speech marked a shift in the discussion around raising interest rates to “a matter of when, not if”.
Willis, however, urged caution: “Pension schemes shouldn’t really be betting the farm on interest rate decisions by the Bank of England.”
Pent-up demand
But David Hickey, managing director of UK institutional advice for fiduciary manager SEI, said while interest rates rising was largely priced into the market already, there could still be opportunity for schemes to improve their positions.
“If rates rise ahead of expectations, funding levels will improve [and] they might want to derisk the pension schemes,” he said.
However, he added schemes must be prepared if they are going to take action.
“There might be nice pockets of opportunity to derisk and schemes should be minded to move quickly to make the best of them,” he said.
Schemes that believe rising interest rates will push down the cost of bonds may take a tactical position with a larger stake in equities, allowing them to buy more bonds when the price drops, Hickey said.
He added: “We’ve seen some clients re-risk, but not many.”
However, Hugh Nolan, chief actuary at consultancy JLT Employee Benefits, warned schemes not to underestimate the number of investors waiting for the price of bonds to drop, meaning schemes should be ready to move quickly.
He said: “My feeling is there’s pent-up demand for gilts in the market. I think as the price goes down some people will buy, which will make [a drop in price] more gradual.”
Nolan added: “You need to be ready to move when the market does. Get a trigger set up in advance and pull it when it happens.”
