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16 August 2013 last updated
Pension annuity income risk as Bank of England may start QE again

As gilt yields soar pension annuity income is under threat as the Bank of England's Mark Carney may have to start another round of QE to keep the cost of borrowing and interest rates down.

The bank of England has indicated it will freeze interest rates at 0.5% until mid 2016 unveiled by the Governor Mark Carney with the new "forward guidance" policy allowing investors scope to plan for the future.

Markets have brought this expectation forward and are driving up yields on bonds and gilts with the 15-year gilt yields rising 33 basis points in August.

Annuity rates are closely linked to yields and a 33 basis point rise will result in a 3.3% increase in annuities by providers.

The increases in yields indicates markets have ignored forward guidance increasing the price of sterling and cost of borrowing for the government. Interest rates will increase when unemployment reduces to 7.0% down from the current level of 7.8%.

Pension annuity income risk with more QE
  Rising gilt yields may see Bank of England launch £25 billion of QE sending annuity rates lower
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Quantitative Easing back on the table

The Monetary Policy Committee (MPC) have decided to keep interest rates at 0.5% and Quantitative Easing (QE) at £375 billion and are prepared to wait to see how the new "forward guidance" policy is received by the market.

The Bank of England is worried that the costs of borrowing will increase and are hoping "forward guidance" can give sufficient direction to control sterling and yields. If this does not succeed it is likely that the MPC will in a couple of months apply £25 billion to QE taking the programme to £400 billion.

The Governor Mark Carney has previously taken action to keep interest rates down when he was Governor of the Bank of Canada so it is very likely he will take the same action in the UK.

Impact on pension annuity rates from QE

Quantitative Easing was introduced in March 2009 and requires the bank of England to print electronic money which is used to purchase UK government bonds and gilts. This increases the price and reduces the yield and a fall in the yields will mean a fall in the income people can receive from their pension funds.

Since march 2009 pension annuity rates for our benchmark example of a male aged 65 with a fund of £100,000 buying a single life, level annuity reduced from £7,309 pa to a low in January 2013 of £5,373 pa and has since increased to £5,944 pa. Over this time 15-year gilt yields decreased from 4.17% to 2.02% in August 2012 and have since improved to 3.26% today. The last time yields were at this level was in September 2011.

Standard annuity rates have not followed the recent rise in yields for August so there is an opportunity in the medium term of a 4.44% increase. From the above example this would mean adding 263 pa to a new high for the year of £6,207 pa. Even so it may be short lived with another round of QE which would certainly see yields reduce to under 3.00% although likely to remain clear of the lows reached last year.

For people buying their annuity now they can expect improving annuity rates for the next four weeks until mid September when the US Federal Reserve may announce a tapering of their stimulus package which will send equity markets lower with bond and gilt yields higher. If this happens the Bank of England would have to react with more QE to send yields down resulting in a combination of lower equity markets, lower annuities and less income from pension funds in October.

News related stories:
Retirement annuities threat as yields fall on UK and US stimulus plans
Annuity rates boost as Bank of England rejects more stimulus
Pension annuity rates threat of £175bn QE from Bank of England
Current annuity rates may increase with no QE stimulus proposed
Related internet links:
BBC - Bank of England holds rates at 0.5%
Telegraph - Mark Carney may relaunch QE to keep down interest rates
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