Government is only making pension problems worse with QE

by Dr. Ros Altmann

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ANOTHER week, another major policy mistake as the authorities attempt to cope with our economic crisis. The Bank of England has begun its new policy experiment of 'quantitative easing' (its fancy term for what is normally known as printing money).

The Bank plans to create up to £150 billion, at the stroke of a computer key, and has this week spent the first £2 billion of this 'new money' buying UK Government bonds (also called gilts) from institutional investors.

It hopes the institutions selling these gilts will use the money they receive to help stimulate our flagging economy. I can tell you now this policy just won't work. Not only that, it will inflict even more pain on pensions and future pensioners - who were already major casualties of the battle to bail out borrowers and banks.

Buying Government bonds like this aims to push up the market price for gilts due to the extra demand created by the Bank of England, and this lowers the interest rate they have to pay to attract investors.

The Government bond market sets the tone for interest rates on all other bonds so the idea is that as interest rates on Government bonds fall, interest rates on bonds issued by other UK companies will also fall, thereby enabling them to fund their borrowings more cheaply.

I know this is a bit technical but let me try to explain. Most companies issue bonds to finance their businesses. These 'corporate bonds' allow companies to borrow from investors. The company has to pay these investors a rate of interest.

The stronger the company, the lower the rate of interest they have to pay because investors are more confident that the company can repay. They will be willing to pay a higher price for a stronger company's bonds.

But smaller or weaker companies have to offer a much higher interest rate to attract investors and the higher the interest rate they have to pay to borrow money- i.e. the lower the price the investors are willing to pay for the bonds - the worse it is for the struggling businesses.

In particular, it is smaller companies who desperately need money to survive. So for the Bank of England's new policy to work investors must use the money they receive from selling their gilt holdings to buy bonds issued by smaller or medium-sized UK companies, which will increase the price of these bonds and make it cheaper for the companies to borrow.

But, if the aim is to help company borrowing, why has the Bank chosen the indirect route of buying UK Government bonds rather than directly buying UK corporate bonds, which are its real target?

The policy relies on institutions switching their gilt holdings into smaller UK company bonds. But this just won't happen.

Firstly, many of the institutions selling their UK Government bond holdings are not even British! Foreign investors cannot believe their luck. The UK Government is paying them over the odds for their gilts. These overseas investors are not going to switch the money they receive from selling UK Government bonds into much riskier smaller UK company debt. In fact, they may not even deposit this money into UK banks so the money will go abroad without helping the UK at all.

Secondly, even UK institutions who sell their gilts will probably put some of the money into overseas Government bonds.

Thirdly, institutional investors are more likely to buy top-quality companies' bonds - both in the UK and abroad - rather than those of smaller or medium sized UK companies. So again the money the Bank of England gives investors when buying their gilts will not reach the Government's intended target. It will help overseas government and corporate borrowers more than the domestic companies who so urgently need the money!

But it is even worse. Not only will this quantitative easing not work, it is causing further damage to our already wounded pension system. As bond interest rates are artificially forced lower, pension funding gets worse and worse. This hits companies, whose pension deficits are ballooning, it hits individuals who find the cost of buying their annuity has soared and it hits all pensioners living on their savings who have seen the interest on their money all but disappear.

As the Bank of England has pushed gilt and corporate bond yields down, pension deficits have increased dramatically. In February alone, UK final salary scheme deficits worsened by 10 per cent - they are now over £220 billion, compared with £60 billion a year ago.

And don't think that doesn't affect the ordinary person. It is not just final salary pension schemes that are being damaged, everyone with personal or stakeholder pensions or any other type of company scheme will be hit. New pensioners and workers coming up for retirement face a dreadful dilemma. Stock market falls have wiped out over a quarter of most people's pension funds recently, and now the cost of buying their annuity pension income for life has increased by about 10 per cent as a result of the Bank of England forcing bond yields down with its quantitative easing. About 400,000 people buy annuities each year and most of them will receive a pension 35 per cent lower than they would have expected last year. This means far more pensioners risk ending up on benefits and in poverty.

Pensioners are the hidden victims of Government attempts to shore up the banking system. Their assets and incomes have been decimated. Someone with £20,000 in the bank a few months ago would have received £1200 a year (£24 a week) in interest. With rates now almost zero, that income has disappeared. If they had a portfolio of shares, the value has plunged (any holdings in Royal Bank of Scotland or HBoS are now nearly worthless) and the dividend income has nearly all gone. These older citizens, who did all the right things and planned carefully to look after themselves have been robbed by official policies. Their money is going to younger borrowers and bankers. Now, with quantitative easing, money is even going to overseas governments and companies.

Whoever is advising the Government simply does not understand how institutional investors operate and how much damage pensioners are suffering. Buying gilts is a huge mistake and once again will cause significant collateral damage, yet miss the intended target.

Government should be getting money directly to the companies that need it. It must take charge and spend our money wisely, rather than spraying it around indiscriminately and making our pension problems worse.


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