30 September 2021 last updated

Bank of England could raise base rates sending gilt yields higher

Annuity rates could rise 3.2% due to higher gilt yields following Bank of England comments.

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The Bank of England considers raising base rates by the end of the year due to higher inflation sending gilt yields up 24 basis points this week.

With the fear or higher inflation in the fourth quarter of the year, the 15-year gilt yields increased 24 basis points over the last week from 1.00% to 1.24%.

As annuity rate changes are mainly based on gilt yields which have increased 32 basis points for September, it is likely that providers will raise income by up to 3.2% should yields remain at current levels.

The increase in gilt yields this week follows comments from the Bank of England on 23 September that there is a case to increase base rates due to higher than expected inflation. The forecast for inflation is now over 4% by the end of the year which is twice the 2% long term target.

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All members of the monetary policy committee (MPC) are prepared to raise interest rates before Christmas to prevent inflation from rising even higher.

Two policy makers supported the immediate halt of the £895 billion bond buying programme which was scheduled to continue until the end of the year.

Fig 1: Chart comparing annuity rates and 15-year gilt yields

The above chart shows the 15-year gilt yields compared to our benchmark of a person aged 65 years old with a fund of £100,000 buying a lifetime annuity on a single life, level basis.

Gilt yields started the year at a low and this was 0.54% before increasing 69 basis points to 1.23% by March whereas annuity rates where slower to change. Since January 2021 gilt yields have increased 8.40% compared to only 4.08% for our benchmark annuity rate suggesting on this basis income can increase by 4.32%.

For our benchmark example a person aged 65 years old could purchase an annuity with income of £5,065 pa at the beginning of September. Based on a 32 basis point rise in gilts this month provider s may increase this by £162 pa in increments over time, if yields stay at current levels.

Bank of England base rates

The UK bond buying programme is likely to continue until the end of the year although in the US the Federal Reserve Chair Jerome Powell said they are in a position to reduce the bond buying programme later this year.

Bank of England Governor Andrew Bailey said that there is a need for some tightening of policy to meet inflation targets in the medium term.

There is a general view that the stimulus to monetary policy introduced as a result of the Covid pandemic would start to unwind at some point. This would occur by an increase in bank rates and would not need wait until the end of the bond buying programme.

In the US the Federal Reserve Chair Jerome Powell said the central bank would reduce the bond buying programme later this year. With improvements in the US economy and progress in terms of its inflation target the Fed would consider tapering bond purchases to start towards the end of 2021.

If the Bank of England raises base rates it is likely to be the first quarter of 2022 from 0.1% to 0.25% and possibly another rise a couple of months later.

Assuming this is the case, gilt yields and annuity rates are likely to increase during the first quarter of 2022 in anticipation of the base rate rise as information about medium inflation becomes clear.