Commenting on today’s Consumer Price Inflation (CPI) announcement, Chris Arcari, Head of Capital Markets, Hymans Robertson, said:

“While today’s release shows year-on-year headline CPI inflation unchanged from August’s release, it has generally stayed on a downwards trend this year and core CPI edged down slightly. Prior to release, swap markets still implied a c.50% chance of a rate rise at the November meeting and a 100% chance that rates will have been raised at least once, to 5.5% p.a., by the end of the year. However, attention is increasingly shifting from how far rates will be raised, to how long they will remain at current levels.

“Regardless of whether the Bank of England raises rates at either the November or December meetings, both the tone of the central bank’s comments and market pricing suggest that policy rates are at or close to peaking, but subsequent cuts will be gradual. Declines in energy prices have been a key contributor to the reduction in headline inflation over the last year, and so any reversal could slow the downtrend. Central banks might choose to ‘look through’ the immediate impact of a temporary, supply-driven increase in energy prices. However, the risk of second-round effects, alongside sticky core inflation and tight labour markets, are reasons why central banks may proceed cautiously with rate cuts. 

“One potential positive from the recent downtrend in inflation, on the growth front at least, is that year-on-year wage growth is now positive in real terms. However, this is a double-edged sword: if real wage growth supports demand and feeds back in to price pressures, the Bank of England may be encouraged to keep rates higher for longer.”

Commenting on what today’s CPI announcement may mean for the pensions market, Ben Farmer, Senior Investment Consultant, Hymans Robertson, said:

“While the pace of price rises may have slowed versus this time last year, inflation remains elevated and, while falling, is expected to remain above target for some time.

“The September CPI release is particularly relevant for DB pension schemes, as it forms the basis for many schemes’ annual increases that will be applied from April 2024, meaning it’s of interest to pension managers, trustees, sponsors, and members alike.

“With the caps that apply to annual pensions increases in payment in the private sector usually set at 3% or 5%, persistent high inflation may mean well-hedged, mature DB schemes might see a slight funding gain, as their index-linked gilts have no such caps. For less well-hedged schemes, this second-order benefit will likely be swamped by the general rise in the liabilities from high inflation. The picture is more nuanced for deferred members (i.e. not yet retired), where benefit increase annual caps are typically applied cumulatively, and who likely stand to gain from the full extent of the current (high) inflation.

“As with last year, perhaps this morning’s release will raise questions among trustees and sponsoring employers about the potential for awarding discretionary increases to their members’ benefits. Many private sector DB schemes are focussed on managing their way towards a low risk ‘end game’ objective, be it run-off or an insurance transaction, meaning an unexpected increase in liabilities from the awarding of discretionary benefits is unlikely to be welcomed.

“With many schemes still in funding deficits, the focus for trustees remains first and foremost on paying the benefits defined in their scheme deeds and rules, particularly with the potential for further asset volatility in the coming months amid an uncertain economic and geopolitical environment.”