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5 September 2013 last updated
Annuities boost as market defies Bank of England rate freeze

Annuities were given a boost with 15-year gilt yields rising to their highest point of the year at 3.35% up 12 basis points today after markets continue to defy the Bank of England and their policy.

The Bank of England Monetary Policy Committee (MPC) has decided to keep interest rates fixed at 0.5% this month.

This follows Governor Mark Carney
new "forward guidance" policy to freeze interest rates at 0.5% until mid 2016 allowing investors scope to plan for the future.

Annuities are benefiting from the markets continued defiance by moving funds away from UK bonds and gilts thereby lowering the price and increasing the yield which are 19 basis points higher this month.

Annuity rates are primarily based on the 15-year gilt yields. As a general rule this would translate into a 1.9% increase in annuity rates at some point which means people retiring now will benefit from more income from their pension fund.

 
Annuities boost as market defies BoE
  Markets are pushing up gilt yields to new highs despite low interest rates to the benefit of annuities
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Pressure builds as economy improves

The Bank of England is under pressure as good figures have been released for the UK manufacturing with the purchasing managers index (PMI) increasing to 57.2 where a figure of 50 or more indicates expansion and below contraction. UK services are also growing at the fastest rate for six years with a PMI of 60.5.

The reason for interest rates remaining at 0.5% is to help the economy to recover and Mark Carney would not consider increasing this until unemployment fell below 7.0%. The strong data from manufacturing and services suggests he may need to increase interest rates sooner than mid 2016. The economy is still at an early stage of recovery so the Bank of England may need to resort to other methods to reduce the cost of borrowing.

There was also no change with Quantitative Easing (QE) remaining at £375 billion. One of the options open to Mark Carney would be another round of QE by increasing the level by £25 billion taking the programme to £400 billion.

Annuity rates likely to rise with gilt yields

There is an expectation that the over inflated bond market will shrink and this has already seen the yields improve from a low of 2.02% in August 2012 to 3.35% today. The chart below shows how annuity rates and the 15-year gilt yields have changed since July 2008.

Annuities vs gilt yields
Fig 1: Chart comparing annuity rates and 15-year gilt yields

Although 15-year gilt yields have recovered 128 basis points since reaching their low, UK annuities have not kept pace. In fact annuity rates continued to fall until reaching an all time low in January 2013 after the EU Gender Directive introduced Unisex pricing.

Since August 2012 pension annuity rates are 4.84% higher but gilt yields are 12.8% higher suggesting rates could improve in the long term by 7.96%. This may take several years and providers are pricing to keep tack of short term changes in yields at the moment.

Annuity rates may never full catch up as the EU Gender Directive gave providers an opportunity to reduce male rates while increase female rates. Overall it would seem there is a significant difference developing in the market which will take time to close.

People buying their annuity now can expect higher rates this month although to really benefit in the long term a fixed term annuity would allow you to take an income initially and return to the lifetime annuity option at a later date. This would allow you to benefit from higher annuity rates in the future and if poor health occurs in the mean time, the potential for higher rates from an impaired annuity.

News related stories:
Pension annuity income risk as Bank of England may start QE again
UK annuities boost as Fed plan to taper QE to start from September
Retirement annuities threat as yields fall on UK and US stimulus plans
Annuity rates boost as Bank of England rejects more stimulus
Related internet links:
BBC - Bank of England maintains interest rates at 0.5%
Telegraph - UK services grow at fastest rate for six years
BBC - UK service sector at six year high
Guardian - Strong service data signals UK growth
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