Pensions World QE Article
by Dr. Ros Altmann
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The Bank of England’s policy of ‘Quantitative Easing’ (QE), is a huge monetary experiment with dangerous and damaging side-effects for UK pensions which are being insufficiently appreciated by policymakers.
Having exhausted its capacity for conventional monetary policy as short-term interest rates approached zero, the Bank still wanted to add more stimulus. It therefore embarked on QE, which aims to lower long-term interest rates by buying government bonds with newly-created central bank money.
The idea is that the money received by sellers of gilts (often pension funds or other institutional investors) will be deposited in their bank accounts. This increase in bank deposits is supposed to increase bank lending to UK businesses and stimulate the economy. In addition, the Bank expects gilt-sellers to also reinvest in other, more risky assets such as equities, to help the economy.
That is the theory, but there is precious little evidence QE is actually working. The economy has been flatlining, inflation has risen and bank lending has fallen. In fact, no one really knows whether QE will work as intended. Many investors have reinvested the money overseas – thereby boosting other countries’ economies rather than our own. This has also weakened sterling, boosted commodity prices and contributed to high inflation, which itself has sapped consumer confidence and harmed economic growth.
In fact, the damaging side-effects of QE may have offset the expected beneficial economic impacts and actually could be depressing, rather than boosting growth.
The £325billion already committed to QE means the Bank of England will have purchased gilts to the equivalent of more than one fifth of UK GDP and well over a third of the total value of UK gilts issued. Such vast purchases have pushed up gilt prices and pushed down the long-term interest rates which underpin UK pensions.
Since QE started, pensions have suffered across the board. The lower gilt yields fall, the larger defined benefit pension liabilities become. A 2% fall in long-term interest rates increases liabilities by around 40% (assuming a scheme with 20 year duration). So the impact of falling bond yields is substantial – the NAPF estimates QE has already worsened scheme funding by £90bn – and means sponsoring companies have to divert resources away from their business, in order to shore up their pension scheme, which harms growth.
The Bank of England has defended QE by suggesting it has boosted equity values and other risk assets (or caused them to fall less than they might otherwise have done), so pension funds equity or other assets have risen in value however, the rise in liabilities has been far greater than any such effects.
QE has also damaged defined contribution pensions. Anyone recently, or soon-to-be retired, who has to buy an annuity, will be permanently poorer for the rest of their life, since lower gilt yields mean lower annuity income. Since 2008, annuity rates have plunged by over 20%. Around half a million annuities are bought each year, leaving these pensioners with lower incomes and less money to spend.
And those in income drawdown cannot escape QE either. The amount they can withdraw from their pension fund each year is set by the Government Actuary’s Department (the GAD rate) and the lower gilt yields fall, the lower the GAD rate. Therefore, QE is reducing the incomes of large numbers of retirees, lowering economic growth, as increasing numbers of people have less money to spend.
Overall, QE has been dreadful for pension funds and pensions. This monetary experiment may also be causing a new asset bubble in the supposed-to-be ‘risk-free’ asset which underpins all other asset markets. As the UK pension system is far more dependent on government bond yields than other countries, and given our demographic profile, the Bank of England should not ignore these effects. QE needs to be urgently reconsidered.
Dr. Ros Altmann
21 March 2012