Interest rate cuts and rising inflation so soon after the vote to leave the EU have significantly increased pension scheme deficits in FTSE 100 companies.
According to consultancy Lane Clark & Peacock’s annual report on the pensions market, by the end of July, the combined deficit of the FTSE’s largest blue-chip companies was an estimated £46bn. In 2015, the deficit was £25bn.
According to Richard Parkin, head of pensions at Fidelity International, this sharp spike in deficits necessitates “close inspection”, but he warned against a “knee-jerk” reaction.
“Schemes are again back in the spotlight with reports over the past few days highlighting a sharp increase in deficits thanks to falling long-term interest rates,” he stated.
“While deficits are clearly a big issue, it is important not to react to this news with knee-jerk measures.”
He added the recent spike in deficits had been driven by falling long-term interest rates caused firstly by the referendum result on 24 June, and more recently, the Bank of England’s monetary operations.
Earlier this month, the Monetary Policy Committee dropped rates from 0.5 per cent - a position they had held since March 2009 - to 0.25 per cent, whilst also injecting another round of quantitative easing into the UK economy.
Diverting resources from investment and capital to repair what is, at the moment, a paper loss could be ill-advised Richard ParkinAs a result, gilt yields - on which many pension schemes rely to reduce their liabilities - have fallen. For example, the 15-year gilt yield has dropped from 2.25 per cent in 2015 to just under 1 per cent today.
Mr Parkin noted that while this may seem like a small fall, compounded over the long term it has the effect of significantly increasing liabilities. “While the value of long-term bonds has also increased, by as much as 30 per cent in the past year, if schemes weren’t fully invested in these assets this will have increased their shortfalls.
“Of course a balance needs to be struck between paying shareholders and repairing deficits. But given the potential stormy waters ahead for UK business, diverting resources from investment and capital to repair what is, at the moment, a paper loss could be ill-advised.”
The monetary policy move came as the consumer price index (CPI) measure of core UK inflation ticked up to 0.6 per cent in July, the highest level recorded since November 2014.
According to Mark Billige, managing partner at London-based Simon-Kucher & Partners, slowly increasing inflation in the first half of this year has cost British households £1.4bn, or almost £55 per household, compared to a year ago.
“We forecast continued growth in inflation as higher import costs from the devalued sterling find their way into consumer prices.”
He said as July was the first month where CPI numbers were based on post-Brexit figures, meaning it was the first time the effect of the devaluation of the sterling on import prices could be observed.
With inflation ticking up slowly and the central bank reducing interest rates, some advisers considered the policy action to have been too soon.
In a poll carried out by FTAdviser Advantage, 27 per cent of advisers believed the BoE’s strategy, particularly QE, has been harmful to pensions.
A further 36 per cent believed the fiscal policy decision was necessary, but had come too soon after the vote to Brexit.
David Lamb, head of dealing at Fexco Corporate Payments, said the policy actions would have a possible further downward push on the value of sterling.
“The irony is enough to make an economist wince,” he commented. “The pound, whose slump following the Brexit vote is blamed for the rise in inflation, responded to the news of CPI increasing by rallying.
“The weak pound is widely seen as the prime suspect behind Britain’s inflationary fears. For it to rise on the CPI increase is a bit like the criminal showing up to help in the manhunt,” he added.
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