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23 October 2013 last updated
Retirement annuities to benefit earlier when BoE raise interest rates

The Bank of England has indicated that interest rates may rise sooner than expected as the economy continues to improve faster than expected which would see gilt yields rise to the benefit of retirement annuities.

The Governor of the bank of England Mark Carney launched their "forward guidance" policy to freeze interest rates at 0.5% until mid 2016 allowing investors scope to plan for the future.

The trigger for lower interest rates would be unemployment reaching 7.0%. They are at 7.7% now and this is down from Carney's announcement on forward guidance in September when it was at 7.8%.

At that time annuities gained as the market defied the BoE by selling bonds and gilts expecting interest rates to rise after improving manufacturing and service data. As annuity rates are mainly based on the 15-year gilt yields the lower price improved yields with providers quickly increasing rates ending the month 2.28% higher.

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Retirement annuities ahead of yields this year

From the second quarter of the year both standard and impaired annuities have displayed robust improvements in rates rising aggressively after a slow start to the year.

A significant end to 2012 due to the EU Gender Directive absorbed considerable amounts of retirement annuity business earlier depressed rates in early 2013 but competition has placed rates ahead of yields. For example, compared to the end of last year annuity rates are higher by 10.9% whereas the 15-year gilt yields are higher by 7.2% suggesting rates have a further 3.7% to fall.

This is unlikely to happen in the short term as long as yields remain above the 3.0% level and this depends on economic factors, mainly in the US and UK.

Bank of England buoyant on UK growth

With sterling strengthening the Monetary Policy Committee (MPC) would expect to see inflation lower and to date it have been above the 2% target since december 2009 and currently at 2.7%.

Manufacturing continued to expand with the purchasing manager index (PMI) at 56.7 in September down from a 19-year of 57.1 in August. The services sector also expanded with a PMI of 60.3 in September again slightly lower than August at 60.5.

Interest rates remain at 0.5% and the intension is to leave them there until 2016 but if the UK economy improves at the current growth rate of 3-4% per annum with falling unemployment the Bank of England may consider raising interest rates earlier.

The markets are expecting interest rates to rise in 2015 and had driven yields to a high of 3.38% in September along with the expectation that the US stimulus would start to be tapered. The delay of tapering has brought uncertainty to the market and with the US debt ceiling crisis resulting in a partial government shutdown there is likely to be a knock on effect with for US growth.

For the moment the market seems to be in a neutral position with no particular direction with the 15-year gilt yields hovering at 3.02% awaiting more direction from policymakers in the US and UK.

Buying annuities better value than start of year

For people retiring the market for annuities remains strong having recovered from all time lows in January 2013 and coupled with rising equity markets.

For example for a person aged 65 with a fund of £100,000 could have purchased an income from a single life, level annuity of £5,373 pa in January 2013. A combination of rising equities would have increased the fund to £106,341 with higher annuity rates the income would now be £6,400 pa, an increase of 19.1% or £1,027 pa.

In terms of lifetime income, the Office of National Statistics (ONS) would expect a male to live for 17.3 years and he will have £17,767 more over his lifetime. For a female she can expected to live for 20.4 years increasing her income by £20,950.

News related stories:
Annuities boost as market defies Bank of England rate freeze
Pension annuity income risk as Bank of England may start QE again
Retirement annuities threat as yields fall on UK and US stimulus plans
Related internet links:
BBC - Bank of England points to improving economic picture
Guardian - Interest rates may rise next year says Bank of England
Yahoo - Bank of England Hints of earlier interest rate rise
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