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21 February 2013 last updated
Pension annuity rates threat of £175bn QE from Bank of England

After questioning the economic effectiveness of QE last year, three members of the Monetary Policy Committee (MPC) voted to add £25 billion and up to £175 billion if the economy struggles to make reasonable progress.

Pension annuity rates are based on the 15-year gilt yields and since the start of the year yields have increased by 45 basis points reaching 2.76%. As a rough guide a 45 basis point rise would eventually result in a 4.5% increase in annuity rates.

The last time Quantitative Easing (QE) was injected was July last year with £50 billion raising the total to the current level of £375 billion. As a result gilt yields reduced by 26 basis points to an all time low of 2.02% in August.

A return to QE would damage the fragile annuities market which has started to turn the corner and recover after reaching an all time low level for annuity rates in January, helped by the EU Gender Directive and introduction of gender neutral pricing.

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QE will be used if the economy struggles

In a recent speech David Miles of the Bank of England explained how their asset purchasing model would work to tackle a struggling economy. This follows comments earlier in the month from the OECD that also suggested the UK should use Quantitative Easing to help the economy.

This model is also supported by the future Bank of England governor mark Carney so suggests the developments this month are in support of a future strategy. Miles has said that there do not seem to be any other options to help the economy expand other than the asset purchasing model and if it is deemed that QE is not as effective now as it use to be, more government bonds should be purchased to achieve the same effect.

The key of this model is the amount of slack in the economy if this is between 0% and 3% the amount of QE should be £60 billion and if this figure is 0% to 6% the figure should be £175 billion. QE would continue until the Bank of England can forecast growth in the UK of 3% per year over the next three years. UK growth is not expected to reach 2% until 2015 so this model would be a long term strategy.

The minutes of the monetary policy committee (MPC) meeting that decides on interest rates and Quantitative Easing show that Sir Mervyn King, Paul Fisher and David Miles voted for extending the programme by £25 billion to £400 billion.

Risk to pension annuities and pensioners

An aggressive programme of QE especially injecting a further £175 billion would increase the price of gilts and reduce the yields, possibly to lower levels than were experienced last August. This would certainly force annuities to lower levels the longer the programme was running.

At the same time inflation is currently at 2.7% which is above the 2% target set by the Bank of England. QE increases the money supply to the economy and this tends to increase inflation and the cost of living. Pensioners experience higher levels of inflation on average and the combination of lower pension annuities and high cost of living will make pensioners poorer more quickly.

News related stories:
Current annuity rates increase possible with no QE stimulus
UK annuity rates may lower as QE expected with falling inflation
Pension annuity buyers biggest losers from QE
Annuity rates threat as Bank of England injects £50 billion of QE
Related internet links:
Telegraph - Bank of England split on more QE
Guardian - Bank of England governor outvoted on QE boost
BBC - Bank of England Sir Mervyn King outvoted on QE move
Telegraph - QE may need to be raised by £175 billion
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