The Bank of England increased its benchmark interest rate by 0.5 per cent to 2.25 per cent following a non-unanimous decision in which three policymakers supported an increase of 0.75 percentage points.
The increase comes as the Sterling is once again declining and inflation is predicted to peak at 11 per cent in October.
Hymans Robertson co-head of Investment DB Elaine Torry says: “Today’s rate rise from the Bank of England is rightly going to grab the headlines, reflecting the very real impact that it will have on businesses and consumers alike. However, for pension scheme trustees, it’s a bit of a double-edged sword. For schemes less than 100 per cent hedged to interest rates, the wider rise in yields that are being seen in the market will be a positive, isolation, for funding levels.
“But the challenge that is almost overshadowing this improvement for many schemes, is the balancing act that is having to be performed between managing risk and sticking to strategy versus the practicalities of fielding collateral calls and maintaining hedging positions.
“With asset allocations for some schemes drifting 5-10 per cent off benchmark, trustees are faced with the decision about running an out of kilter risk profile, selling illiquid assets at potentially 20 per cent haircuts, or accepting interest rate and inflation risk to increase in their portfolios. With tomorrow’s fiscal statement or mini-budget, as the first announcement from the new Chancellor there remains further uncertainty for many.
“DB Trustees must evaluate whether this interest rate hike and subsequent knock-on effects, present an ironic opportunity to take advantage of improvements in funding positions or whether running to stand still will continue to dominate time and attention.”
Royal London Asset Management senior economist Melanie Baker says: “The Committee want to wait until November to fully digest the impact of fiscal changes. The pace of rate increases might plausibly step up then, depending on what else is happening in the economy and especially on measures of domestically-driven inflation. Three MPC members did vote for a 75bp rate hike today.
“The decision to raise rates was clearly about inflation. They noted signs of continuing strength in domestically generated inflation and suggested that the energy bill freeze would add to inflationary pressure in the medium term.
“My forecasts assume that this is not the last BoE rate hike in this cycle by any means, with a peak around 3.50 per cent next year and risks skewed to the upside of that projection.”
XPS Pensions Group senior consultant Charlotte Jones says: “A rise of at least 0.5 per cent was already anticipated by investment markets, with a c2.7 per cent rise in long-term government bond yields since December 2021 reducing liabilities of UK DB pension schemes by £750bn, nearly 35 per cent.
“Analysis by XPS’s DB: UK funding tracker shows that UK pension schemes are now in surplus, with the improvement in funding positions largely attributable to rising interest rates. The energy cap should lead to prices rising less quickly than previously feared, but with the future far from certain, pension scheme trustees should strongly consider taking measures to lock in some of these gains by reducing levels of risk in their investment strategies or securing members’ benefits with an insurance company”.
Hargreaves Lansdown senior investment and markets analyst Susannah Streeter says: “The starting whistle has been blown on the economic tug of war between the Bank of England and Liz Truss’ government. This is a more prudent pull on the monetary policy rope than had been widely expected. Even so, as it’s the seventh rise in quick succession, it still shows determination by the Bank to pull inflation down from stubbornly dangerous levels in terms of financial stability. Rates have raced up from 0.1 per cent to 2.25 per cent in less than a year, representing a sharp increase in borrowing costs, on top of the painful rise in energy and food prices.
“Policymakers are digging in their heels and will be bracing for the counterattack from the Treasury, with Chancellor Kwasi Kwarteng widely expected to be hanging tight on his resolve to cut taxes to try and stimulate growth, with the mini-budget set to be announced tomorrow. Team Bailey at the Bank of England wants to squeeze demand out of the economy, to try and stop the spiral of prices, while Team Truss wants to stimulate it, risking prolonging the pace of rate hikes.
“The Bank of England’s strategy may be unprecedented, but it’s recently become a well-trodden path, and up ahead the US Federal Reserve is leading the way, having raised rates by 0.75 per cent for the third time in a row yesterday, and signalled there were more robust hikes to come. There may have been some dissent around the table at the Bank of England, about the size of the rate hike, but there is unanimity about the direction of travel, given that inflation is set to peak at 11 per cent in October. The warning is clear – if inflation continues to be persistent, policymakers won’t hesitate to respond much more forcefully.
“The pound has been suffering as the dollar has gained more strength amid expectations the Federal Reserve will keep staying ahead of the pack. If the Bank of England relaxes its grip on rate rises, sterling could be dented considerably further, which could see inflation slipping ahead again due to the impact of pricier imports. Already the pound has fallen on the news, back to below $1.13 and the Bank won’t want this pattern to accelerate further.
“Neither side seems inclined to blink first in this face-off, with the government more intensely focused on stopping a deeper recession from forming in the months to come. The Bank of England’s forecast that inflation is set to stay at double digits for months to come is unlikely to weaken the Truss administration’s resolve to put growth first.
“The energy price freeze has made Threadneedle’s task a little bit easier, as inflation is now not expected to peak at the really scary level of over 20 per cent, but the pressure is still on. Given the shock and awe tactics of other central banks, who appear to be bringing forward planned rate rises for 2023 into the next few months, the Bank of England is also expected to keep pulling tight on the monetary policy rope to try and tug inflation down with forecasts that interest rates may reach anywhere between 3.5 per cent and 4.75 per cent. It’s clear the path ahead is fraught with uncertainty.’’