Commenting on today’s Bank of England interest rates hold, Chris Arcari, Head of Capital Markets, Hymans Robertson, said:

• “There has been some nervousness about the fall in bond prices. For those heavily invested in long-term bonds, the value of their pots will have declined over the last two years. However, longer-term yields mean annuity rates have risen very rapidly. That is, it is cheaper to buy a retirement income so the amount of assets required is less.”
• “The Bank holding rates steady at 5.25% pa today was not unexpected by the market. Despite inflation remaining at more than three times the bank’s target in September, recent data is just about encouraging enough to justify this pause.”
• “The Bank's decision will also have been influenced by where it thinks inflation is likely to be in the near future.”

Chris Arcari explained:

Why rates were held: “The BoE isn’t targeting realised inflation – it’s targeting where inflation is expected to be on its forecast horizon. A reduction in the energy cap versus last autumn’s large increase is expected to show headline inflation fell to 4.7% year-on-year in October. Goods prices are also expected to fall further, given weak producer-price inflation, with food-price inflation also expected to have moderated sharply. Meanwhile, UK PMIs point to a weakening in UK economic activity that should put further downwards pressure on inflation. However, sticky core inflation and strong wage and service-price growth are likely to keep the BoE cautious about cutting rates over the next few years. Interest rates are likely to stay higher for longer – as policymakers have indicated, the near-term interest-rate profile is expected to look more like Table Mountain than the Matterhorn.”

“Longer-term bond yields have also risen – much more so than shorter-dated yields. One might be tempted to assume this represents a de-anchoring of much longer-term inflation and interest-rate expectations. But inflation expectations haven’t risen very far over recent months. Instead, the rise in long-term bond yields appears to represent an increase in the ‘term premium’ – the additional compensation for investors to hold a long-dated instrument to maturity, rather than rolling a short-term deposit. Put another way, it’s the yield over and above what’s expected from the average of future short-term interest rates.”

Impact on pensions: “Rises in long-term bond yields, of course, go hand in hand with declines in the value of long-term bonds. But viewing pensions purely from the asset side is incomplete, in our opinion. A rise in long-term yields will reduce the value of a defined-benefit pension pot from a member’s perspective, but that’s because the rise in long-term yields has reduced how much it costs in today’s money to provide promised, fixed benefits. Indeed, that’s why, on average, defined-benefit pension scheme funding levels have improved rapidly over the last two years – higher yields mean the promised pensions are ‘discounted’ at a higher rate, so the overall liability has fallen (in most cases, more than assets have). Similar thinking can also be applied to defined-contribution pension pots. For those heavily invested in long-term bonds, the value of their pots will have declined over the last two years. However, longer-term yields mean annuity rates have risen rapidly, so it’s now cheaper to buy a retirement income.”

Commenting on the interest rate hold from the Bank of England, William Marshall, Chief Investment Officer – Hymans Robertson Investment Services (HRIS) says:

“Earlier this week, the British Retail Consortium released data showing a large fall in high-street inflation, especially for food. In addition, signs that the labour market is weakening have continued to emerge over the past few weeks, with unemployment rising and wage growth falling, although still high. Other sources of data indicate that wage growth might even be lower than the official figures. The BoE has started to put more weight on these alternative data sources such as HMRC’s PAYE, especially as the ONS recently cautioned that the accuracy of their labour market data is becoming increasingly uncertain. Potentially dodgy data is far from ideal for the BoE but they will take comfort that it is at least heading in the right direction.

“Although it is looking increasingly likely that we have reached the peak in interest rates, the BoE has been keen to reiterate that they expect rates to be held at this level for a sustained period of time – markets are not pricing in a rate cut until next Autumn.

“Investors might think that the level of interest rates on offer makes it an opportune time to save in cash rather than investing. It is correct that cash is more attractive than it has been for a number of years, but the same can be said for bonds and other assets that should still deliver better returns in the long-term.”