Latest blog: The unleashing of €60bn (£45bn) a month of quantitative easing by the European Central Bank last week could mark trouble ahead for UK pension schemes, as greater demand for gilts pushes yields ever lower and liabilities higher.
Draghi’s big reveal felt a little bit like last year’s announcement of a new Star Wars film. Like Star Wars, we have already seen quantitative easing episodes I, II and III (true fans do not count the prequels).
First, the Federal Reserve brought in its wholesale bond buying programme in late 2008, an action that has seen it inject $4.5tn (£3bn) into the US economy, with monthly purchases peaking at $85bn.
Then we watched the Bank of England put forward its own quantitative easing programme, buying £375bn of UK gilts and high quality private sector assets over three years.
Finally, Abenomics in Japan brought its own bond-buying programme. The country began QE in 2010, but October last year saw the surprise announcement that the asset purchase would expand to ¥80tn (£450bn) per year to rekindle the nation’s economy.
What does QE mean for UK schemes?
Simon Hill, chief investment officer at Buck Consultants, said the scale of the ECB’s QE may leave the eurozone wanting more. “Even though the numbers sound large, in the global context they’re not that remarkable. The numbers won’t have that big an impact – little impact compared to the halving of oil prices in the past six months,” he said.
Danny Vassiliades, head of investment consulting at consultancy Punter Southall, said that with more QE than was expected – an additional €10bn a month above predicted levels – the potential impact on UK gilts could be much greater.
“The news is worse than expected for UK schemes. Investors will now look to other kinds of debt for yield,” said Vassiliades.
The hunt for yield has been the key challenge for pension scheme managers struggling to counter the rise of scheme deficits in recent years. Tesco's defined benefit scheme became the latest victim of the yield squeeze earlier this month as the company announced plans to close its scheme.
The present value calculation of schemes’ deficits is based on the yields of long-term government bonds. Data from the Pension Protection Fund's monthly index showed at the end of December 2014 an aggregate deficit of £266.3bn for PPF-eligible schemes, an increase of £45.2bn in just one month.
On the equities front, the rally in European stocks may have played out in three to six months time said Hill, who added the real danger for schemes lies in currency, where he anticipates volatility over the next few months, and urges schemes to consider whether and how they can hedge against this uncertainty.
He said: “One – schemes must take a view to currency hedging and hedge against those they think will weaken over time. The second point is a longer term structural one, even if you don’t expect currencies to diverge from one another is it worth being exposed to exchange rate volatility."
When will it end?
At this stage the QE programme is set to run from March 2015 until September 2016, but Draghi’s rhetoric seemed to leave plans a little open-ended.
Draghi said the scheme would continue until there was a “sustained adjustment in the path of inflation that is consistent with our aim of achieving inflation of close to 2 per cent”.
The road to QE has not been an easy one for the ECB, and there are doubts as to the potential of the programme to reignite the eurozone.
The outlook from consultants is one of concern for future liabilities and caution over currencies, coupled with doubts about the programme's potential to offer real change over the long term. For now though, the market must sit back and watch the latest chapter unfold.
