Why high rates are a godsend for some British businesses
Bond markets seem to be getting ahead of themselves in anticipating a steep fall in Bank Rate next year.
CPI inflation has come down a long way since the double digit heights of last year. But at 4.6pc in the 12 months to October, it is still running at more than twice where it should be, and although the economy as a whole is barely growing, there isn’t much sign of belt-tightening among consumers.
Even house prices are picking up a bit.
What is more, tightness in the labour market isn’t easing off either; if the Government goes through with plans to raise the qualifying wage for legal migration, it is set to get tighter still. This will put further upward pressure on wages and prices.
In any case, the Bank of England is far from declaring the battle with inflation won. At the conclusion of its latest meeting this Thursday, the Monetary Policy Committee is almost certain to leave the Bank Rate unchanged at 5.25pc.
I’d also be amazed if it significantly changed its language on the future trajectory of interest rates, which is that “...monetary policy is likely to need to be restrictive for an extended period of time”.
Higher for longer is the prevailing mantra among central bankers these days.
Despite this, investors are pricing in a cut in UK Bank Rate of atleast 75 basis points over the next year, a far more significant fall than was expected just a few months back.
We’ll soon see who’s right, I suppose, but in the meantime it’s worth pointing out that not everyone wants to see a pronounced fall back in rates.
Besides net cash savers, there is another key group of economic constituents for whom higher interest rates are proving a godsend – companies with legacy defined benefit pension schemes.
It is one of those actuarial curiosities that when interest rates go up, it reduces the expected size of future liabilities, and therefore the amounts that have to be set aside by the sponsoring company to cover any shortfall.
The past era of very low interest rates was as a consequence disastrous for many companies, forcing them to plug deficits from profits that might otherwise have been applied to higher investment, dividends and wages.
Some companies came to be regarded as no more than prisoners of their legacy pensioners, their only purpose being to feed the leviathan of pension fund obligations.
Just another symptom, it might be said, of a country that had become captive to its past, with resources increasingly focused on servicing the old, rather than building for the future.
Rising interest rates have dramatically changed this dynamic, such that most companies now find their final salary pension funds to be in surplus, and can therefore free themselves of the necessity to make substantial extra annual contributions.
How come? The business law firm Osler explains it like this: “In conducting an actuarial valuation, many future events must be assumed or predicted.
“These assumptions include life expectancy, age of retirement, general salary increases, and interest rates. In general, when calculating the present value of future assets and liabilities, actuaries discount future cash flows by using a discount rate linked to long-term interest rates.
“An increase in long-term interest rates means that the liabilities, or the discounted value of future cash flows of a pension plan, would decrease. This, in turn, could lead some defined pension plans to have a surplus.”
Indeed it has. In its latest annual “Purple Book”, the Pensions Protection Fund estimates that on a full buy-out basis, the net funding position of Britain’s remaining 5,063 defined benefit pension schemes improved to a surplus of £149.5bn from a deficit of £438.4bn the year before. The funding ratio thereby improves from 79.2pc to 111.9pc.
All over the shop, companies are gleefully calling an end to the dispiriting process of constantly having to cough up to fund pension fund deficits.
It’s all a bit of a charade really, since whether a company has a deficit or a surplus depends crucially on the assumptions used, including what happens to interest rates, and is therefore in the end just an accounting fiction.
If rates go back to near zero, then today’s surplus quickly becomes tomorrow’s deficit.
Yet the parameters are meticulously prescribed by regulators, who in turn try to ensure that pension funds are at all times in a position to meet future liabilities. i.e. close to or actually in surplus.
Given the very long term nature of pension liabilities, and the unknowable future price of the assets used to back them, this can never be anything more than a matter of judgement, which almost by definition is bound to be flawed in some respect.
Requiring pension schemes to de-risk themselves so that they should in theory always be in a position to fund future liabilities is obviously a good thing if you happen to be one of their beneficiaries.
But it has been disastrous for the UK stock market, forcing a wholesale switch out of risky equities and into gilts, and by diverting profits into pension funds, not at all helpful to the wider interests of the UK economy.
Companies that are constantly required to plug pension deficits are unlikely to invest heavily in the future of the economy.
How much difference the change in the interest rate landscape, and the consequent removal of deficit funding obligations, makes in practice to Britain’s lamentably poor business investment record is open to question, but every little bit helps, and it certainly cannot make things any worse.
The parallel may be a little stretched, but just as we are now rethinking the wisdom of lockdown – widely accepted at the time as necessary in the fight against Covid – the benefits of more than a decade of ultra-low interest rates are equally being questioned.
It may have helped save us from the fall out of the global financial crisis, but it sure did have some very unfortunate consequences for the allocation of capital. As with lockdown, there never was a proper cost/benefit analysis, a weighing of the pros against the cons.
There was manifest justification for the zero rates of quantitative easing in the immediate aftermath of the financial crisis, but then it just became the norm. The Bank of England carried on with the money printing simply because everyone else was doing it.
Let us hope that the lessons have been learned. Money that has no price will end up worthless, and destroying the economy.
This article is an extract from The Telegraph’s Economic Intelligence newsletter. Sign up here to get exclusive insight from two of the UK’s leading economic commentators – Ambrose Evans-Pritchard and Jeremy Warner – delivered direct to your inbox every Tuesday.
