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The Actuary The magazine of the Institute & Faculty of Actuaries

Reaction to Bank of England quantitative easing proposals

J.P. Morgan Asset Management
Paul Sweeting, European head, strategy group:
"QE will lower Gilt yields, and also spreads if the market believes that this move will stimulate the economy. Combined, these factors could cause a significant rise in the value of pension plan liabilities. To the extent that pension schemes are invested in bonds, the effect on their solvency will be limited. What's more, if this move does secure economic growth, then return-producing assets should also see some recovery. As a result, the net effect should be positive for pension schemes, but the strategy is not without risks.

"The main risk is the risk of inflation. Although inflationary pressures have been eased by the recent falls in commodity prices, QE may still result in a rise in inflation - after all, it will be introducing additional liquidity into the economy thorough the banks. High levels of inflation can be bad for equity returns and, if the Government is not buying back bonds, for gilt yields.

"It is also worth considering the motivation behind this move, and the risk of inaction. Economic growth is slowing and with rates as low as they are, buying back bonds is one of the few ways the Bank of England can try to prevent the economy stagnating - a situation that would be bad for all investors, including pension schemes.

"On a related note, the downward pressure on yields could also force annuity prices higher, reducing the amount of income new pensioners receive. This means it could make sense for people retiring to defer the purchase of an annuity, instead drawing income from their pension pots until annuity prices are more favourable."

Pension Corporation

Mark Gull, partner:
"It appears that this money will be primarily be used to buy gilts with maturities from 3 years to 25 years. Avoiding buying very long dated gilts and index linked gilts will lessen the impact on pension fund liabilities but as gilt yields are driven lower, pension fund deficits will still rise.

"In its statement the BoE has added ‘the strains in bank funding markets may also inhibit the availability of credit to consumers and businesses.' We iterate our view that as the BoE recognises the strains in bank funding these could be alleviated by buying financial bonds - so directly bringing down banks' funding costs. After all, in the last round of QE, the BoE bought non-financial bonds to help non-financials with their cost of funding."

Punter Southall

Danny Vassiliades, principal:
"UK pension schemes may end up paying a ‘QE premium' as this latest round of QE may cause the double-whammy of driving down gilt yields and driving up inflation expectations, both of which increase the value placed on UK pension scheme liabilities."

"It is unclear exactly how the Bank of England intends to use the additional £75bn of QE, but nearly all of the Banks' previous £200bn of QE in 2009 was used to buy Government bonds and helped gilt yields to fall by just under 1% (source: Bank of England, Q3 2011 quarterly bulletin). The Chancellor's letter to the Governor of the Bank of England outlines that a maximum of £50bn may be used to purchase eligible private sector assets. However, if this new round of QE is used to buy back more long dated Government bonds, then this could suppress gilt yields even further. Price inflation could also increase if the new money generated by the QE does not find its way into new goods and services."

"We call for the Pensions Regulator to issue guidance to UK pension schemes on how to deal with this ‘QE Premium', caused by gilt yields being artificially suppressed."

Hymans Robertson
Russell Chapman, head of financial risk management:
"While the full impact of this decision will take time to emerge, a further quarter-point (0.25%) fall in yields would add another £25bn to FTSE350 pension liabilities. For many pension schemes, 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.

"Equity markets might respond positively to the stimulus. Interest rate protection looks expensive at the moment, but if we are entering a long term, low growth environment, it may be worth paying up front for that protection.

"The key point for pension schemes is that economic conditions remain challenging and the outlook is uncertain. This increases the need for Trustees and Scheme sponsors to develop a clear plan for managing their pension fund risk. Volatile markets mean there are likely to be opportunities to reduce risk through trimming equity or inflation hedging, and schemes need to position themselves to take advantage."

Ernst & Young

Nida Ali, economic advisor to the Ernst & Young ITEM Club:
"We believe that more QE has now crossed its buy-back date and are sceptical about its effectiveness in boosting growth. Long term gilt rates have now been pushed down to all-time lows and it is hard to see another QE effect here. Asset prices may not respond given the current uncertainty in the market. Moreover, even if this cash does find its way into the coffers of large companies, they are likely to sit on the cash rather than invest it."

Aon Hewitt
Colin Robertson, global head of asset allocation:
"Already under stress from historic lows in gilt yields, the UK's pension funds would undoubtedly find that, by depressing yields even further, QE2 only exacerbates pension funding problems. This stands to place even more of a burden on UK companies already buckling under the weight of the pension promise, with implications for employment and hence the economy."


Azad Zangana, European economist:
"In our view, the restarting of quantitative easing will boost confidence and asset prices in financial markets, but we remain sceptical over its power to restart lending, and therefore have a meaningful impact on the real economy. Where QE might have an impact is on Sterling. If the purchases of assets leads to a depreciation in Sterling, then this could boost demand for UK exports. However, this would also raise inflation for households, who are already struggling to make ends meet...

"Given our scepticism on the impact of QE, we would not be surprised if the Bank of England is forced to announce even more QE in February 2012, as the latest programme comes to an end."

Russell Investments
Sorca Kelly-Scholte, head of consulting and advisory services:
"Our view is that this underscores the fundamental supply/demand imbalance in the gilts market, where pension funds have been on the wrong side for quite some time and will continue to be following this round of QE. It is clear that pension funds will not be able to hedge out all of their liabilities, or even extend their current hedging programmes significantly, while this imbalance persists - even if they were to accept the cost of hedging at current low interest rates.

"Many plans have put in place mechanisms such that their liability hedges will be extended as and when interest rates rise and hit certain triggers, but the prospect of hitting these triggers is receding further into the future. Trustees need to recalibrate their expectations as to how quickly they will be able to derisk through further hedging, and consider other ways in which to manage their overall portfolio risk - having a plan for future derisking is no substitute for managing risk right now."

Dr Ros Altmann, director general:
"More QE will worsen inflation and lower long-term interest rates, which will worsen pension fund deficits and lower consumer confidence, thus actually damaging, rather than stimulating sustainable growth."