Quantitative easing has forced pension funds to put money in low-yielding government bonds, putting them at a significant risk from interest rate rises, the Centre for Policy Studies think-tank has argued.
“Unconventional” monetary policy has driven bond yields down, but to meet guaranteed liabilities, defined benefit funds and life insurers have had to up their positions in long-term stable assets, the CPS says in a paper today.
Combined with new regulation such as Solvency II, the CPS says this has caused a misallocation of capital, and that a rise in interest rates would quickly erode the value of fixed-rate assets like bonds.
The CPS says: “Low interest rates are causing severe problems for long-term investment institutions such as life insurers and defined benefit pension funds. These institutions have long-term liabilities, which they must match with long-term assets such as government bonds alongside riskier assets which will produce the returns sufficient to allow them to profitably meet outflows.
“But as bond yields have fallen, given the quantitative restrictions, these funds must invest more capital in these bonds to generate enough income to pay its members their guaranteed monthly pension or to meet other liabilities.
“This leads to the bizarre result that quantitative easing policies which have reduced the yield on bonds can lead funds to acquire more of these low-yielding assets. This again misallocates capital away from its most productive uses. Furthermore, if there is a return to inflationary conditions occasioning rapidly rising interest rates holders of fixed coupon assets such as government debt will suffer greatly from a sharp fall in market asset valuations.”
The CPS cites research suggesting that the recent cut in the base rate and extension of quantitative easing has helped push pension deficits up.
According to actuarial consultants Lane Clark and Peacock, the combined deficit of FTSE 100 companies that disclosed pension deficits at the end of July was £46bn, increasing to £63bn by 9 August, five days after the Bank of England cut the base rate from 0.5 per cent to 0.25 per cent.
The CPS paper says: “Unfortunately, while QE programmes have reduced yields they have bolstered bond prices so these deficits are being “filled” by purchasing government debt which will fall raising the deficits as interest rates return to normality.”
The Bank of England has denied that QE has hurt businesses with pension deficits however.