On the go: The Bank of England's decision to slash its base interest rate to 0.25 from per cent 0.75 per cent will swell defined benefit liabilities, according to experts, who doubt the ability of monetary policy to ease covenant concerns but say Budget measures may offer some help.
Alongside the rate cut on Wednesday morning, the Bank announced a package of measures designed to ease economic stress resulting from coronavirus, including lower capital buffers and cheap funding for banks, in return for an expectation that they do not increase dividends.
But the likely impact on gilt yields of the monetary policy committee's unanimous decision to cut rates could spell further pain for defined benefit pension schemes, who have already seen their funding levels dented by sliding equity markets and compressed yields, which have a knock-on effect on discount rates.
Simeon Willis, chief investment officer at XPS Pensions Group commented: "The cut in the bank rate from 0.75 per cent to 0.25 per cent today could prove bittersweet for pension schemes. The surprise move will likely bolster asset values such as equities but will add weight to the falling gilt yields.
"These falls have proved to be as much, if not more damaging, to pension funding levels than equity market falls so far this year. Pension liabilities have risen substantially off the back of falling gilt yields which at the shorter maturities are linked closely to the bank rate."
Mr Willis and other commentators have cast doubt on the ability of monetary policy to respond to shocks to supply and demand associated with workers having to stay at home.
"There are differing views on whether monetary policy can provide effective support in response to coronavirus," Mr Willis said. "The rationale being you can’t boost the economy by encouraging people to spend money if people can’t go to work to meet the demand. The side effect therefore could be a rise in inflation which would add to pension scheme liabilities."
Last week, analysis from Hymans Robertson suggested the initial impact of the virus had added £100bn to DB deficits in just seven days. In addition to a headline slump in funding levels, the economic impact of the virus could hurt the covenant – the ability of sponsors to make good shortfalls.
If monetary policy may prove ineffective, fiscal stimulus announced in the Budget on Wednesday may offer more help. Included in a £30bn package of measures was a government refund for 14 days of statutory sick pay costs for small and medium-sized businesses.
"The fiscal stimulus and support package has scope to help in a more direct way," said Mr Willis. "There are still limits to the extent that any government action can offset the negative impact of coronavirus but crucially the steps proposed in both the Budget and the Bank rate reduction will help, rather than hinder, companies getting through this challenge, and that is a very good thing."
