How QE can damage your pension

“What possible impact could QE [quantitative easing] have on me?” asked a friend in his late fifties as we shared a lunchtime beer last weekend.

A general mood of celebration enveloped us and we imbibed because he has finally decided to retire in a few years when he reaches the age of 62, primarily because the mortgages on both his house and a small holiday cottage will be repaid by then. “I’ll feel rich,” he declared, another valid excuse to raise a glass.

I reminded him that retaining good health was considerably more important than ‘feeling rich’. He agreed, prompting a conversation about those matters which the modern fifty-something bloke must begin taking into account. Anyone who has ever seen Billy Connolly describe the pain inflicted by his doctor during a particularly intrusive examination will know what I’m talking about. We winced at the prospect, ignoring its essential nature.

“QE will affect you,” I finally retorted, “because if it continues, it’ll have a negative impact upon your pension.” I felt as though I’d thrown a bucket of cold water over my pal, dampening his buoyant mood. Thankfully, another beer caused him to lighten up again.

My friend is not alone in believing that QE is something remote and distanced. How could the Bank of England’s printing of £375 billion possibly have an impact, other than inflationary, on pensions of ordinary folk?

Such an attitude is dangerously widespread and is likely to become even more acute following the introduction of compulsory pension auto-enrolment at the beginning of the month. Pension savings are hugely important, but ultimately, it’s what you do with them that matters.

So when the Bank ‘creates’ new cash – which it does electronically rather than switching on the printing presses – it uses the money to buy government bonds, more commonly known as gilts. It’s at this point that the simple rules of supply and demand come into play.

Once the money created by QE is credited to its account, the Bank becomes a major buyer of gilts, ie it increases demand for them. As any GCSE student will tell you, when demand for a product of finite supply increases, its price goes up. The immediate effect of the Banks buying is to reduce the return (ie, the yield) on gilts.

This matters because pension funds too are major buyers of gilts. Accordingly, if the gilt yield falls, so the return pension funds can offer on annuities to people such as my pal looking forward to an early retirement also drops.

Ignored following the inaugural waves of QE, the strategy’s debilitating impact upon soon-to-be-pensioners, namely those about to use the proceeds of their pension pot to buy an annuity, is finally being recognised. Since 2009, the value of annuities has fallen by 20%. Indeed, they’ve plummeted by more than 7% in the last three months.

For those on the cusp of retirement, who have saved hard and made sacrifices, the news comes as a devastating blow.

What makes matters particularly galling is this: the money the Bank of England is using to buy gilts, primarily from our high street banks, is not finding its way back into the economy in the form of lending, either to businesses or individuals, but being used to strengthen their respective balance sheets.

QE might be hailed as a strategy which prevented a banking sector implosion, but as its implications begin to become more apparent, be it for those approaching retirement or people searching for mortgages or business loans, one wonders at what longer-term cost.

posted on 12 October 2012 09:47 byPJS