Thursday’s announcement by the Bank of England that the base rate remains at 4% will help keep gilt yields high, buoying funding levels for defined benefit funds, but for defined contribution savers, the impact of high inflation could have long-lasting consequences. 

Wage growth and sticky inflation in the UK – at 3.8%, it is above the Bank’s 2% target and noticeably higher than in the US, France or Germany – have swayed the MPC to keep interest rates on hold, despite anaemic economic growth, putting it on a different path to the US Federal Reserve, which recently cut its rates by a quarter point. 

Some experts think little will change for defined benefit investors. “For pension schemes, the impact will be minimal, as long-dated gilt yields and inflation expectations are moving somewhat independently of short-term rate decisions and inflation prints,” said Simeon Willis, chief investment officer at XPS Group. 

 

Defined benefit schemes have benefitted from rising long-dated gilt yields, he noted.

“However the dynamics of the gilt market has varied considerably across different maturities. Short end yields have been tethered by the Bank rate, whereas long-dated yields reached their highest levels this century in early September with 20-year gilt yield reaching 5.7%, and are currently sitting just under this recent high watermark,” he observed.  

 

Current demand for long-dated gilts, combined with a market expectation for reduced future long-dated issuance, have kept up demand for the longest maturity gilts available, which remain relatively expensive compared to the rest of the gilt market, he argued. 

  

“Overall, schemes are benefitting from higher funding levels, but volatile gilt dynamics make managing liabilities a choppy ride,” he said. 

 

On the other hand, some commentators have said in the past that the Bank of England’s programme of actively selling gilts it bought during the Covid pandemic and previous crises has had a downward effect on prices. Christopher Mahon, head of dynamic real return at asset manager Columbia Threadneedle, believes the central bank’s ‘quantitative tightening’ has raised yields by about 40 basis points, higher than the Bank itself estimates.   

 

“There are very, very few markets where you can sell £50bn or so a year and not affect the price level,” he told mallowstreet last year.  

 

The Bank of England will be shedding £70bn worth of gilts in the 12 months from October, mostly through run-off but including £21bn of active gilt sales – less than the £100bn a year it has been moving off its books since late 2022. Any losses the Bank makes are indemnified by the Treasury. The Office for Budget Responsibility has estimated the cumulative lifetime cost of the bank’s Asset Purchase Facility to be a net loss of £104.2bn.  

   

   

Dean Butler, managing director for retail direct at Standard Life, said the Bank of England faces a difficult balancing act given the various economic pressures.

However, the Fed’s cut could yet influence it, he said: “While the two banks are operating in different environments, it also raises questions about how long the Bank of England can resist following the Fed, particularly in the context of the UK’s fragile growth outlook.”  
 

Other are not so sure. While markets are betting on rate cuts resuming next year,  George Brown, senior economist at asset manager Schroders, is doubtful these will materialise. 

"In our view, the balance of risks is drifting towards renewed tightening given persistent domestic inflationary pressures. We continue to expect rates to remain on hold this year and next, but we can’t rule out the possibility that the Bank’s next move will be up, rather than down,” he said. 

 
If inflation and mortgage rates remain high, this could spell difficult times ahead for defined contribution savers. Research from PensionBee has found almost one in three (30%) said they are reducing longer-term savings amid the cost of living squeeze.  

Maike Currie, vice president personal finance, said inflation is not only chipping away at the value of future income payments and eroding the worth of pension pots, it also affects contribution rates. 

 
“This fiscal belt tightening is impacting pensions. Over half (51%) of people spoken to have either considered or already reduced or paused their pension contributions in the past year. For too many, retirement savings are at risk as they weigh up sacrificing their future financial security to cover today’s rising costs,” she said.