Schemes face a multitude of economic challenges in 2016 and beyond, but it’s not all bad news according to former Bank of England Monetary Policy Committee-member Andrew Sentance
What are the biggest economic issues facing pension schemes in 2016 and beyond?
Persistent low interest rates are probably the biggest economic challenge facing pension schemes. Long-term interest rates have been coming down over a prolonged period and central banks are being very cautious about normalising monetary policy after the financial crisis. Achieving an acceptable investment return without taking undue risk has therefore become much harder.
There are also other challenges arising from increasing longevity and uncertainty over wage increases, inflation and economic growth.
Finally, many companies which are sponsors of pension schemes are operating in an increasingly competitive business climate, which is being reshaped by technology, changing energy prices and shifts in the global economy. In that environment, assessing the strength of the corporate sponsor and developing a strategy to protect the pension scheme is becoming increasingly important.
Just how much influence will central bank policies have on global markets?
Global financial markets are expecting a very gradual rise in interest rates and the continuation of a high degree of monetary support for growth. However, concerns about the long-term impact of extremely low interest rates - and in the case of some countries negative rates - are growing. A reassessment of monetary strategy could lead to a sharper and sooner rise than markets currently expect, particularly if inflationary pressures start to build up. That could deliver a shock to current financial market expectations, and cause an adjustment in bond markets and in the values of some other financial assets.
When do you expect the BoE to change the official bank rate, in which direction will it go, and will investors have to get used to a ‘new normal’?
I do expect the BoE to gradually increase rates over the next couple of years, and financial markets have perhaps become too relaxed recently about this possibility. However, even if interest rates in the UK do increase they will not be returning quickly to the 4-5% level seen before the crisis. A move up to an official Bank Rate of 2-3% by around 2020 is a more realistic possibility.
What about the EU referendum – can we make any confident predictions about how markets would respond to a UK exit?
A UK exit from the EU is not the majority expectation in financial markets, so it would deliver a shock - pushing down the value of the pound and bond prices and creating volatility in equity prices. The main consequence of a UK exit from the EU would be a prolonged period of uncertainty, while the UK renegotiates its relationship with the EU and other trading partners. That uncertainty could create opportunities for investors who trade on volatility, but is probably not helpful to longer term investors like pension funds.
What should trustees fear most in the coming months and years, and what are the reasons to be cheerful?
Leaving the EU would be a shock in the short-term though over a period of time the UK economy could adjust. Global economic and political volatility always has the scope to disrupt economic growth and with interest rates currently so low, it is not clear how central banks and governments would respond if there was a big negative global shock.
On a more positive note, the UK economy is one of the better performing major economies both over the longer term and over the post-crisis recovery. So even if there are future shocks ahead, our economy has the potential to bounce back and should continue be one of the more resilient and successful economies in the western world.