17 July 2012 last updated

Annuity rates may lower if UK inflation fall leads to more QE

Inflation falls near to the Bank of England's 2% target could spell more Quantitative Easing (QE) and risks lowering UK annuity rates for pensioners. The rate of inflation in the UK has reduced to the lowest level since November 2009 with the Consumer Prices Index (CPI) lower at 2.4% in June down from May at 2.8%. The Retail Prices Index (RPI) also decreased to 2.8% from 3.1%. The Bank of England has set a long term target for CPI at 2.0% and at the current rate of decrease this target will be reached in July prompting another round of QE this year. The reason for the fall could be down to the weather resulting in lower than expected prices from retailers together with the days of lost business activity due to the Diamond Jubilee. Also the fall in world energy prices and spending as global economies slow are also contributing to lower inflation in the UK.

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QE may need to be extended

It is likely that the fall in inflation will continue and part of the reason the Bank of England announced £50 billion of Quantitative Easing (QE) as a measure to stimulate the economy bringing the total stimulus to £375 billion. QE requires the BoE to buy UK government bonds and gilts allowing companies to use this money to make other investments and increasing the supply of money in the economy thereby increasing spending and inflation.

It also means the price of gilts increases and the yield decreases and as UK annuity rates are based on the 15-year gilt yields pensioners are likely to see a decrease in annuities, therefore the income they can buy with their pension fund will also decrease. If inflation continues to decrease this summer the BoE is likely to consider more stimulus measures such as further injections of QE especially if CPI falls below 2%. This means pensioners can expect lower annuity rates for the rest of the year and these could go lower still with Solvency 2 and Unisex rates to be introduced at the end of 2012.

Gilt yields may fall further

Gilt yields have reduced with the 15-year gilt yields falling to their all time low of 2.06% with the combined effect of QE and Eurozone's fears in particular with spain and it's borrowing costs. It is likely that gilt yields will continue lower in the short term although in the US the Federal Reserve has disappointed the markets with no indication of it's version of Quantitative Easing, QE3, to help stimulate the US economy.

Once a guaranteed lifetime annuity is purchased the income cannot be changed. To maximise their income in retirement, pensioners retiring now should consider an impaired annuity if they have medical conditions. They could also consider alternative incomes other than the guaranteed lifetime annuity such as with profit annuities or a fixed term annuity where the income can increase in the future.