Annuity rates remain strong

The 15-year gilt yields have increased 26 basis points from 1.41% to 1.67% Countering the fall in gilts in August and giving support to the current high levels of annuity rates.

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

The above table shows standard annuity rates for our benchmark example of a 65 year old buying a single life, level annuity with a fund of £100,000. Rates are now 1.09% higher than they were in January whereas gilt yields remain -1.20% below but this gap is closing.

Since the beginning of the year both annuities and gilt yields reduced by the end of April due to geopolitical uncertainty in Europe, wage data in the US pointing to lower inflation and worries over President Trump's economic policies. Our benchmark example reached a low with an income for a £100,000 fund of £5,108 pa.

Annuity rates bounced back strongly as the ECB suggested the €1.1 trillion quantitative easing (QE) programme would be stopped by the end of the year with investors selling gilts and bonds sending the price down and yields higher.

By August our benchmark example reached a high with an income for a £100,000 fund of £5,473 pa, despite a fall in yields now -3.8% below the January level.

The expectation is for interest rates in the US and UK to rise and the ECB to stop quantitative easing by the end of the year.

Federal Reserve $4.5 trillion portfolio

In addition the Federal Reserve has announced it will begin the unwinding of its massive $4.5 trillion portfolio following the financial crisis and their bond buying QE programme.

This will begin sometime this year and the plan is to slowly allow maturing bonds to roll off its balance sheet at a rate of $6 billion government bonds and $4 billion mortgage-backed securities each month.

Once the Fed stays on the sidelines, demand for bonds will weaken lowering prices and forcing interest rates to climb. This will have a long term impact to raise yields on bonds and gilts although the Fed will act to minimise any short term volatility for equity markets.