Pension holders shouldn’t be concerned about the Bank of England’s announcement that it will stop its bond-buying at the end of this week.
Dan Ashmore, analyst at Invezz, commented: “The latest plunge of the Pound comes in response to Andrew Bailey being forced to deny that the Bank of England will extend its emergency bond-buying programme, meaning its support for fragile pension funds will end on Friday.
In summary, Lizz Truss’ mini-budget was seen as overly aggressive, with her tax proposals and spending initiatives viewed as unsustainable. Tax cuts sound great, but money doesn’t grow on trees, and these cuts are unfunded. This has shot confidence in the UK economy – mostly evident in the collapsing pound and the unprecedented sell-off in gilts (bonds), as investors want out. Bonds are trading at yields not seen since 2002, while the pound is at all-time lows against the dollar.
The problem with regards to the sell-off in gilts is that pension funds rely on these assets as a sort of hedge against their liabilities. With the sell-off so severe, these liability-matching pension funds were required to put up cash against the falling value of their positions, to make what is known as a margin call.
Of course, this only led to even more selling, and hence a further fall in prices, which caused more selling – and a vicious spiral was triggered. The Bank of England hence stepped in to buy these bonds, given the risk to financial stability that the meltdown would cause. The latest announcement this week appears to show the support will end by October 14th, meaning there could be a further sell-off in gilts.
While the sell-off is extremely concerning for the economy at large – with the pound collapsing, mortgage rates on the up, investor sentiment through the floor, government borrowing costs skyrocketing, and a host of other problems – pension holders should not be overly concerned.
The Bank has made it clear that it will not allow financial stability to ripple like a contagion, while pensions will be – and are – getting defended vociferously. This mainly amounts to a liquidity crisis, and once these issues are overcome, the bonds held by pensions should pay a higher rate of interest over the long-term.
The doomsday scenario is whether more pensions than anticipated are engaging in complex investment instruments, such as derivatives that have got caught up in the mess. This could cause funds to lose value, however, it remains an unlikely scenario and one that, in any case, would affect a minority of pensions.”