Pensions Brace as UK Cuts Interest Rate

The Bank of England’s first move in more than seven years spells more trouble for UK pension funds.

The Bank of England (BoE) has cut its base interest rate to a new record low of 0.25% and upped its quantitative easing (QE) program as the UK economy struggles in the immediate aftermath of the Brexit referendum.

“Bigger pension deficits will inevitably lead to calls for a hike in employer contributions.”The decision is a further blow to the funding positions of the country’s pension funds. UK pension liabilities are priced relative to bond yields, which will be pushed down further as a result of the BoE’s decision.

Gilt yields had already hit record lows following the June 23 referendum, and were trading at a yield of 0.67% half an hour after the Bank’s statement.

At the end of July, consultant firm JLT Employee Benefits estimated that the aggregate deficit of UK private sector pensions had risen to £390 billion ($513 billion), a record high. Mercer reported that the combined pension deficit of the largest 350 companies in the country had also hit a record high of £139 billion.

“Following the UK’s vote to leave the European Union, the exchange rate has fallen and the outlook for growth in the short to medium term has weakened markedly,” the BoE said in a statement. 

The BoE also warned of a future increase in unemployment and a spike in inflation. “Consistent with this, recent surveys of business activity, confidence, and optimism suggest that the UK is likely to see little growth in GDP in the second half of this year,” it said.

In addition, the Bank’s monetary policy committee said it was willing to cut the interest rate further towards its “lower bound,” which is “close to, but a little above, zero.”

As well as the rate cut, the BoE pledged to buy £60 billion worth of government bonds and £10 billion of corporate bonds, expanding its QE program to £435 billion.

Charles Cowling, director at JLT Employee Benefits, said the decision was “painful” for pensions. 

“Trustees who have been reluctant to reduce or remove exposure to interest rate risk in their pension scheme, through liability-driven investment or other means, are faced with the dilemma of whether to act now that prices have moved even further against them,” Cowling said. “The risky alternative is to stay in the investment casino and hope that markets are wrong and interest rates rise soon.”

Pensions facing valuations this year also have the prospect of “difficult negotiations” with sponsors, Cowling added, “as bigger pension deficits will inevitably lead to calls for a hike in employer contributions.”

The BoE had held the base rate at 0.5% since March 2009 at the height of the financial crisis. Before the Brexit vote, economists were forecasting a slow upward path for interest rates.

Related: What Brexit Means for LDI & Waking Up to a Different Europe