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30 May 2018 last updated

Gilt yields fall with Italy political turmoil and could hit annuity rates

The 15-year gilt yields have reduced by 31 basis points as uncertainty over Italy's new government drives investors to the safety of bonds and gilts and could result in lower UK annuity rates.

Concerns over Italy's political turmoil are driving investor to sell Italian bonds in faviour of safe havens such as US Treasury, German Bunds and UK gilts.

The crisis has sent the 15-year gilt yields lower by 31 basis points from a high for the month of 1.81% to a low of 1.50%.

Annuity rates are primarily based on these gilts and we would expect providers to reduce rates by about 3.1% at some point.

However, this may be an investor reaction to a short term problem fearing a new general election that could result in a referendum on the euro.

If a political solution can be found providers of annuities can defer a downward movement in rates in anticipation of a recovery in gilt yields over time with little impact on people retiring.

Gilt yields fall with Italian turmoil
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Annuities positive for six months

For the past six months annuity rates have showed a strong performance when compared to 15-year gilt yields as providers have expected a rise in interest rates from central banks.

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

The above chart compares the change in annuity rates and 15-year gilt yields since September 2017. Providers have been more aggressive over this period increasing rates since November with the expectation of higher interest rates with more competition from Aviva, Canada Life, Legal & General and Just.

Since September 2017 the annuity rate for our benchmark example of a 65 year old with a £100,000 fund buying a single life, level income has increased by 3.41%. This compares to gilt yields that have reduced by -1.40% over the same period.

This month 15-year gilt yields increased 14 basis points to 1.81% as the European Central Bank (ECB) said it would bring to an end the quantitative easing programme. The political turmoil in Italy destabilised investor confidence driving yields to 1.50%.

Political uncertainty in Europe

Uncertainty surrounding a coalition government from the anti-establishment Five Star party and the far-right League resulted in a sell off in Italian debt.

Italy’s designated prime minister Giuseppe Conte was unable to conclude the coalition. There remains questions about the intended big spending and tax cut policies of the government even though Italy's current debt is running at 130% of GDP. Worries also remain about the tough stance to be taken on the euro.

The lack of clarity from the government and uncertainty over the future increased the risk of holding Italian bonds resulting in the sell off and rush to other safe havens such as US Treasury, German Bunds and UK gilts.

For annuities the providers are likely to maintain rates until there is more certainty over Italy as the medium term prospect is for interest rates to drive gilt yields higher.

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Related internet links:
Guardian - Italy at risk of financial crisis
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