Quantifying the impact of QE requires one to abstract from these other influences on asset prices. One way of doing that is by looking at the immediate movements in asset prices around announcements of purchases. As market participants are forward-looking, one might expect the bulk of the movement associated with QE to happen when the purchases are announced rather than when they take place. And indeed that approach seems to work reasonably well for identifying the impact of QE1 on the yields on gilts, and those on close substitutes such as corporate bonds. Analysis by Bank staff suggests that long-term gilt yields were around one percentage point lower than they would otherwise have been; that corresponds to a rise in long-term gilt prices of around 20 per cent. Investment-grade corporate bond yields fell by about the same amount, while high-yield corporate bonds fell by somewhat more.
Conceptually, we can split the obligations of a Defined Benefit pension scheme into two components: pension obligations to current and former staff that have already been accumulated; and new obligations arising from the additional pension rights earned by the current staff in the current year through additional service and any increase in pay. The first component will dominate in the case of anything other than a very new scheme, so let me concentrate on that for now. In turn, I will consider the impact on: a fund that is balanced and hedged; one that is initially in balance but exposed to market risk; and one that is initially in deficit, as well as being exposed to market risk.
While the change in the deficit is certainly not trivial for a substantially underfunded scheme, the impact of QE is nevertheless small compared to the movement in the deficit associated with other factors, such as the collapse in equity prices as a result of the financial crisis and the recession. In particular, it would be an error to attribute the deterioration in pension deficits since the start of the crisis solely to the impact of QE.
QE does not inherently raise pension deficits. It all depends on the initial position of the fund, with the movements in liabilities and assets likely to be broadly comparable when a scheme is fully funded. But the more a scheme is underfunded (overfunded) to begin with, the more it will find its deficit (surplus) increased. This is entirely intuitive. By reducing yields, QE increases the cost of purchasing a given future stream of income. So if a fund starts off relatively “asset poor”, the sponsors will now find it more costly to acquire the assets necessary to match its future obligations.
Certainly the impact of QE on yields should ultimately reverse when the economic environment improves and we start to sell the gilts back to the market in order to withdraw the present exceptional monetary stimulus. Unfortunately, with the present heightened uncertainty associated with the problems in the euro area, the likely future date for us to commence selling gilts has receded somewhat. And if conditions do deteriorate significantly, we may need to re-start the programme of purchases. Indeed, as the minutes released earlier today reveal, the decision at our May meeting not to extend the programme was already quite finely balanced. So, in conclusion, while there are reasons to expect yields to return towards historically more normal levels at some stage, it is difficult to know when that will be and how quickly it will occur.
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