The UK's QE2: Good for the economy, bad for pensions?
QE2 may or may not be good for UK companies, but it will surely come as another blow for the long-suffering pensions industry, says Jonathan Williams.
The market was not surprised by the Bank of England's announcement today that its asset purchase facility would soon be allowed to buy a further £75bn (€86bn) worth of UK gilts, attempting to stimulate the UK economy in the process.
Now, one can argue for or against quantitative easing (QE) as a viable economic solution, but two side effects of this measure are without a doubt negative for UK pension funds - the resulting drop in gilt yields and the rise in inflation that will no doubt come as a result of the stimulus.
The Bank of England seemingly again neglected to consider the impact of its programme on a sector already suffering severely from the European sovereign debt crisis and declining stock markets, with consultancy Hymans Robertson saying that a further 25 basis point drop in yields would increase pension liabilities of the FTSE 350 companies by £25bn.
However, Russell Chapman, head of financial risk management, estimates that, despite the price of interest rate hedges rising - as the real rate of swaps becomes negative - pension funds should consider such a protective measure as they enter a long-term, low-growth environment.
"For many pension schemes," he adds, "this will see nearly all of the improvement of the previous two years wiped out, and they may be back to where they were in 2009."
The Pension Insurance Corporation last week went further, saying the impact of the first, £200bn strong round of QE was "diluted" by the impact it had on pension funds, at the time suggesting that, instead of targeting UK gilts, the Bank of England should look at buying corporate bonds, potentially from financial institutions.
But the policy's impact is not simply restricted to falling bond yields, thereby increasing liabilities. The rise in inflation will also have a negative knock-on effect.
The government may have recently changed the measure of indexation, switching from the retail prices index (RPI) to the consumer prices index (CPI), seemingly because the latter saw lower rises than the former, but this switch is all but undone by the likelihood that CPI will rise to 5% by the end of the year.
In short, while the benefits of QE2 could be many and plentiful as businesses' goods become cheaper with the depreciation of the pound, the impact on pension funds - once again forgotten despite the industry's size and importance - is likely to be a further blow after three years of suffering.