The Bank of England has unveiled a fourpronged stimulus package designed to boost the economy and prevent a recession following the vote to leave the European Union.
Sterling tumbled and UK gilt yields dropped to fresh lows after the Bank surprised markets by restarting its money printing programme to buy government and corporate debt alongside the first interest rate cut in seven years.
Subsequently, the deficit of defined benefit or “final salary” pensions, which pay out an income linked to an employee’s final salary, jumped GBP70billion as a direct consequence of the decision to reduce interest rates by 0.25%.
In what economists described as a “forceful response” to an expected UK slowdown, policymakers voted unanimously to cut rates to 0.25%, from a previous record low of 0.5%.
Policymakers signalled that they were likely to vote for further cuts towards zero within months.
In a GBP170billion package of additional measures designed to stimulate the economy, the Bank announced it would:
- Expand its quantitative easing programme by GBP60billion, taking its stockpile of asset purchases up to GBP435billion over the coming six months, from GBP375billion today
- Buy up to GBP10billion of high quality corporate debt from an estimated pool of around GBP150billion to drive down funding costs. While more details will be announced before the purchases start in September, policymakers said buying these bonds “could provide more stimulus than the same amount of gilt purchases”
- Launch a GBP100billion “Term Funding Scheme” designed to offset the impact of cutting interest rates on bank profits. This will allow commercial banks to borrow a proportion of their outstanding lending to UK businesses and households for four years at around 0.25%. The scheme will be funded by new money created by the Bank
Mark Carney, the Governor of the Bank of England said the Bank would take “whatever action is needed” to promote financial and price stability. “Some of the adjustments to this new reality may prove difficult and many will take time. But the UK can handle change,” he said.
As highlighted earlier this week, the funding gap of UK final salary pension schemes has grown to a record GBP390billion, and is expected to reach a high of GBP945billion after the Bank of England cut interest rates.
The Bank’s move, an attempt by the central bank to prop up the UK economy following June’s Brexit vote, has raised fears that pension schemes will be forced to take on more risk.
Research has shown that pension schemes are needing to take on three times more risk to get the same return as twenty years ago (click here to learn more).
There are also concerns that businesses could come under pressure as they struggle to make sufficient contributions to reduce funding gaps within their pension funds.
David Weeks, co-chairman of the Association of Member Nominated Trustees, a trade group for pension fund trustees, warned that a slowdown in growth would hurt pension funds that rely on companies for a large chunk of their funding.
Kate Smith, head of pensions at Aegon, the retirement provider, said today marks another “day of pain” for pension funds.
“Defined benefit schemes are in for even tougher times ahead. Many trustees will seek to negotiate higher employer contributions to make up their scheme deficit,” she added.
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