Low interest benefit the banks, but what about pensioners? - Ros Altmann

    Ros is a leading authority on later life issues, including pensions,
    social care and retirement policy. Numerous major awards have recognised
    her work to demystify finance and make pensions work better for people.
    She was the UK Pensions Minister from 2015 – 16 and is a member
    of the House of Lords where she sits as Baroness Altmann of Tottenham.

  • Ros Altmann

    Ros Altmann

    Low interest benefit the banks, but what about pensioners?

    Low interest benefit the banks, but what about pensioners?

    Markets are living on borrowed time (and borrowed money)

    by Dr. Ros Altmann

    (All material on this page is subject to copyright and must not be reproduced without the author’s permission.)

    Interest rates have stayed at record low levels for far too long. These low rates are great for banks and for borrowers with variable rate mortgages, but they are having a damaging effect on pensions and pensioners, and are distorting all asset markets. This is storing up trouble for the future. The markets are living on borrowed time (and money!) which increases the risk of another financial crash.

    Rates are being kept low because the authorities are afraid that growth will fall sharply next year and is currently too weak. The Bank of England has actually created billions of pounds of new money to buy up Government bonds, in order to stimulate economic growth. This policy of ‘Quantitative Easing’ is quite unprecedented in the UK and is really just a fancy name for printing money.

    In fact, it is a policy experiment and nobody really knows what will happen next. The idea is that the Bank of England buys Government bonds in order to force the interest rates on those bonds down. By buying the bonds, they are putting billions of pounds of newly created money into the economy, which is supposed to find its way into the banking system and then stimulate economic growth. If this money is spent on goods, it will increase growth. If the money is used to buy other assets instead of Government bonds, then those asset prices will rise, which should also boost growth. If the money is used to buy overseas assets (which is largely what has been happening) then it will lead to a weaker currency, which should increase economic growth by making exports more competitive in overseas markets.

    This may all sound good in theory, but my concern is that the effects may help in the short-term, but the policy experiment carries significant longer-term dangers.

    Firstly, by artificially depressing interest rates on bonds, investors have been forced to look for extra returns in much riskier assets. This seems to be creating asset bubbles elsewhere (such as in commodities, and in emerging markets), which could lead to higher inflation in other countries, which could then feed back into our domestic inflation.

    Secondly, by artificially depressing interest rates on Government bonds, the authorities are distorting the gilt market and this means that they are increasing the risk of a sharp rise in gilt yields at some point in the future, once the policy of printing money to buy bonds is unwound.

    The Government bond market is supposed to be a ‘risk free’ asset market. All other assets, such as corporate bonds and shares, are priced relative to ‘risk free’ government bonds. By adding risk to the ‘risk free’ asset, all other assets become more risky and there could be another market crash when the policy needs to be reversed, forcing interest rates up.

    Thirdly, very low interest rates mean many pensioners’ savings income has fallen sharply. In fact, a cut in interest rates is like a cut in the State Pension, since it takes away income they had previously been relying upon. This is potentially economically damaging, as pensioners will have less money to spend and, with an ageing population, this could depress consumption and economic growth – the opposite of the intended policy outcome.

    Low interest rates also mean that annuity rates have fallen sharply, so members of defined contribution or personal pension schemes end up with much lower pensions. Each year, nearly half a million people buy an annuity, so those retiring at the moment are receiving much lower pension income than they would otherwise have had. Once the annuity is bought they cannot change it for the rest of their life. Therefore, depressing long-term interest rates artificially via Quantitative Easing, means that pensioners are being forced to live with permanently lower incomes as a consequence.

    In addition, printing money usually leads to rising inflation. In fact, pensioners and savers have already been hit by high inflation and returns on savings accounts do not match inflation at the moment. With such low interest rates, savers can no longer protect the value of their capital and each year they can buy less and less with their money. Most annuities are being purchased without any inflation protection, so continued high inflation will plunge more pensioners into poverty in future. This, again, could damage economic growth.

    So what can be done to offset the damage of ultra-low interest rates on pensions and pensioners? There are some policy measures which could be introduced to alleviate some of these problems. Government could consider inflation-protection products for pensioners, such as reviving the National Savings products that were recently withdrawn. They were the only really safe way of protecting the value of your savings and it is a disgrace that they have been withdrawn. Government could consider issuing special pensioner bonds, or issuing special bonds for annuity providers and pension funds.

    Keeping interest rates so low will help the banks, but it does tremendous damage to pensions and pensioners. We should be very careful about the risks of this policy.

    Leave a Reply

    Your email address will not be published. Required fields are marked *