We can expect the Monetary Policy Committee, where opinions as to what should happen vary widely, to raise rates further. Certainly Stir, the Short Term Interest Rate future, is suggesting that the hawks are in control and short-term rates will be marching progressively higher in the next few months. Good news for depositors but not necessarily for those who have to buy an annuity.
The level of annuity rates is largely determined by yields at the longer end of the Government securities market. Insurance companies and pension funds like to tuck these long bonds away to ensure that their assets match their liabilities. And this is where the problem arises. Governments are not keen to issue new debt, so there's an imbalance in supply and demand.
The effect has been to push long yields lower. At the very long end, the yield to redemption is now only 4.1 per cent, fully two percentage points lower than the equivalent US bond and around 150 basis points less than 30-year German government paper. Such disparities are pretty well unheard of.
The trouble is that many people buy an annuity once they retire. Indeed you have to purchase one with your present pension when you reach 75. However, like the original retirement age of 65, age 75 was fixed when life expectancy was a good deal less than now. These days, if you reach 75 you can expect a good decade of spending your pension. But if you are forced into buying an annuity at a time when yields are low your quality of life will be hit.
An amendment to the Welfare Reform and Pensions Bill, currently inching through Parliament, aims to abandon the age limit. But there's no guarantee it will be adopted and it will be of little comfort to those who have to buy an annuity.
Will this improve? It might if we enter the single European currency. Pension funds - or the actuaries who govern them - are reluctant to purchase higher-yielding European government paper because of the currency risk. If we were part of Emu they may take a different view. The uncertainty is not helping gilts either. After the poor showing in the last European elections, long gilt yields rose as buyers saw the result as reducing the chance of Emu membership but it was not enough to make much of a difference to annuities.
Even though the Minimum Funding Requirement for pension funds is likely to keep demand for long gilts high, yields as low as this do not look attractive.
For now, I would avoid Government stocks altogether and look elsewhere for the generation of income.
Brian Tora is the Chairman of the Greig Middleton Investment Strategy CommitteeReuse content