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BlackRock's Paul Comments On BoE Rate Rise

Vivek Paul, Director in the Client Solutions team at BlackRock, comments on the Bank of England’s decision to raise interest rates to 0.50%:

"The decision by the Bank of England to increase interest rates for the first time in over a decade provides a timely boost to UK pension schemes, but schemes shouldn’t get carried away - we are not about to revert to historic yield levels.

When the Bank signalled a potential interest rate rise in September, we saw a repricing in the UK government bond market; 20-year real and nominal yields both rose by over 25bps, pushing pension scheme liability values lower and funding levels higher. However, this only takes yields back to where they were prior to the Brexit vote last year.

September‘s signposting, which came as a surprise to many, was consistent with our view that UK interest rates will be higher than the market is expecting in around 5 years’ time. Earlier this summer, we suggested pension funds consider modestly lowering their target hedge ratios in line with this, to benefit more from the anticipated upside to funding levels with rates rising. This is because we saw less downside risk to UK real rates than we saw in the immediate aftermath of the Brexit vote last year, not least due to international factors such as a firmer footing to global growth.

Brexit is likely to continue to loom large, however, and give Bank of England policy makers plenty to consider. Indeed, today’s rate announcement needs to be viewed in the broader context - despite the modestly higher yields we anticipate, UK rates will continue to be very low by historical standards in the coming years, we believe.

Strategic portfolio positioning

As such, pension funds should not get carried away with today’s announcement. While we still think that interest rates will be higher in 5 years’ time, hedge ratios should still be materially higher than the industry averages.  An uncertain political environment given the Brexit negotiations means that interest rate shocks are always possible, even if they are not our core view. Pension funds should position for further upside to rates in the coming years, but not put all their eggs in one basket."