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14 August 2012 last updated
Current annuity rates helped to higher levels with rising inflation

An unexpected rise in UK inflation may mean the Bank of England deferring more QE and allow current annuity rates to recover.

The Bank of England has a 2.0% target for Consumer Price Index (CPI) inflation and since September 2011 inflation has been falling from 5.2% down to 2.4% last month according to the Office of National Statistics.

The sudden increase in CPI inflation to 2.6% for July is due to higher air fares and housing costs and counters the early discounting by retail that has been driving inflation lower.

The use of Quantitative Easing (QE) by the Bank of England also increases inflation and the rise in CPI will deter any further use of this measure until inflation begins to fall again.

It means current annuity rates will have one less factor driving down gilt yields releasing pressure on providers to keep annuities at their current lowest ever levels.

 
annuity rates could rise with inflation
 
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How annuities could increase

Current annuity rates are based primarily on the 15-year gilt yields so a 10 basis point rise in yields would result in a 1% increase in annuity rates at some point. Providers may be quick to reduce annuities when the yields reduce but they are often slow to increase rates when yields rise and wait until another provider acts before they react. For the latest updates see Annuity Rates Review.

Gilt yields decrease if investors in government bonds in other countries such as the Eurozone decide that the risks in Spain and Italy are too great and move funds to other safe havens such as US Treasury Notes, German Bunds or UK government bonds and gilts pushing the price higher and yields lower. Quantitative Easing also results in the purchase of UK gilts by the Bank of England as a way to inject money into the economy and this also increases the price of gilts and lowers the yields.

To improve the income at retirement pensions should ensure that if they suffer from lifestyle medical conditions such as high blood pressure, Cholesterol, smoking or being overweight, an enhanced annuity can increase the income by about 18%. An impaired annuity could pay 40% more incomes than the conventional annuity for medical conditions such as diabetes, heart conditions or cancer.

Even if a pensioner in good health a with profits annuity or investment backed annuity could offer 30% higher initial incomes than the standard open market option. These annuities can go down as well as up so the pensioner needs to accept slightly higher risk although there is a guaranteed minimum income level. The income is also smoothed over time to avoid volatility in the equity markets.

The Bank of England and QE

Currently confidence has increased in the ability of the ECB to protect the euro from a debt crisis and if the Bank of England (BoE) does not extend QE immediately from £375 billion to a higher level, 15-year gilt yields may drift higher after reaching their all time low of 2.02% on 2 August 2012. The BoE will be reluctant to consider another round of QE since announcing the last £50 billion on 5 July with inflation increasing.

More Quantitative Easing would accelerate the rise in inflation away from the target level for CPI of 2.0% and with the Retail Price Index (RPI) increasing at a faster rate from 2.8% to 3.2% in June the BoE would want to avoid further rise in inflation right at the moment. If inflations falls to below 2.0% the Bank of England would certainly look at QE to stimulate the economy so any rise in current
annuity rates may be short term.

An increase in the yields will mean it becomes possible for providers to increase current annuity rates although it is likely yields would need to rise consistently above 2.25% before this can happen. The effect of falling gilt yields over since April 2012 by 51 basis points has not been fully reflected in pension annuities and today Hodge Life reduced their current annuity rates by as much as 2.4%. Hodge Life offers more competitive annuities for smaller funds of £60,000 or less so not all pensioners will be affected by this decrease.

News related stories:
Annuity rates may lower if UK inflation fall leads to more QE
Annuity rates under threat as Bank of England injects £50 billion of QE
UK annuity rates lower with new QE as inflation falls
Retirement income from annuities may be hit with QE measures by BoE
Related internet links:
Guardian - UK inflation rises again after recent falls
BBC - UK inflation rates rise
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