February inflation valuation hits index-linked bonds and PPF payments

Forty per cent of index-linked bonds will see no increase this year because revaluations are based on the February inflation rate that has been announced today as zero.

Experts say pension schemes are set to be hit by today’s shock 0 per cent CPI figures for February, as while many index-linked bonds will see no increase, inflation is likely to have increased again by September when scheme benefits are traditionally increased.

PPF payouts that are increased in line with May’s inflation figures look set to be suppressed this year as the country is predicted to experience several months of near-zero inflation.

Barnett Waddingham associate Richard Gibson says: “As many pensions became linked to CPI by the coalition government in 2010, low inflation can mean lower payouts for pension scheme members. This could be good news for some pension schemes and employers who are struggling with increased liabilities.

“Many pension schemes set their benefits according to the rate of inflation each September, by which time we could see CPI back closer to its 2 per cent target.  Those more likely to be affected are former employees of insolvent companies who are receiving compensation from the Pension Protection Fund lifeboat.  The PPF pays out increases based on inflation in May each year so a dip lasting a few months will mean lower pensions in future for them.

“But low inflation could also spell bad news for pension schemes and corporate sponsors – more than 40 per cent of the index-linked bonds that pension schemes use to protect themselves against inflation pay out each year based on the February inflation rate – a temporary dip in RPI inflation during February will mean pension schemes not getting the full inflation protection they are looking for.”

Schroders pan European equities business cycle team member Charlotte Morrish says: “Taken together, we are inclined to agree with the Bank of England’s analysis in February’s Inflation Report that the fall in energy prices over the last six months has been largely driven by an increase in global supply rather than a fall in global end demand, which means that the recent decline in inflation should be positive for domestic demand – consumer spending and business investment – and serve to prolong the UK’s business cycle. If end demand remains positive, then falling prices should not feed through into wage negotiations and the current low rate of inflation is, therefore, likely to be temporary. In the short-term this means that the UK’s interest rate trajectory is more likely to be driven by labour market data than movements in the headline inflation rate.  Our expectations for continued growth in the UK economy and a long-awaited corresponding pick up in wage growth are unchanged.”