How does the Labour Budget impact pension schemes?

Executive summary:

  • Gilt yields have risen in a modest and orderly fashion which, depending on hedging, is largely a positive on pension scheme deficits.
  • Sterling, on the back of an initial drop in value, has recovered and the UK equity markets saw limited impact, with large-cap stocks (such as those in the FTSE 100) largely unaffected.
  • The movement in gilt yields has been more modest which, along with better collateralised LDI portfolios, has ensured that there was no repeat of the dramatic events post the October 2022 mini-budget. 
     

The first Labour Budget in 14 years has generated a lot of discussion in the media, bringing significant fiscal changes with potential effects across markets and the economy. While these shifts are less dramatic than the 2022 mini-budget, they certainly aren’t without consequences. Here’s our breakdown on the market reaction and the impact for pension schemes.

Market reaction

The immediate market reaction to the Budget was relatively subdued, with gilt yields remaining stable during the announcement. However, as the Office for Budget Responsibility (OBR) released its economic projections, yields began to rise. This rise reflects the reassessment by markets of the Bank of England's (BoE’s) potential future rate cuts, as the OBR’s forecasts suggested a stronger-than-expected demand in the UK economy.

Key figures from the OBR include projected GDP growth rates of 1.1%, 2%, and 1.8% over the next three years, as well as inflation forecasts of 2.5%, 2.6%, and 2.3% for the same periods. These projections indicate moderate growth but could place constraints on the government's ability to meet its fiscal targets. Since gilt yields are critical in determining the present value of liabilities in pension schemes, the upward trend in gilt yields could impact the funding status of some schemes.

The relationship between the Treasury and the BoE appears well-coordinated, suggesting that the central bank was prepared for the Budget's outcomes. While the market has dialled back its expectations for rapid rate cuts, there is still an expectation for the BoE to lower rates over the coming months, albeit more cautiously than previously anticipated.

Sterling and equity markets

Sterling initially dropped by around 1% following the Budget but has since made a modest recovery. The currency's performance reflects broader economic uncertainties but remains relatively stable over a longer timeframe, showing resilience compared to other major currencies. For pension schemes with overseas investments, sterling’s fluctuations can impact the portfolio, though the effects here are modest given the level of currency hedging typically employed.

 

Source: xe.com
 
The UK equity markets saw limited impact, with large-cap stocks (such as those in the FTSE 100) largely unaffected by the Budget. Smaller companies experienced a temporary boost due to anticipated inheritance tax breaks that were not fully implemented.

Gilt yields

Rising gilt yields have had a mixed impact on pension schemes. While higher yields reduce the value of gilts in portfolios, they also lower the present value of liabilities. Currently, we view the net effect of these opposing forces are keeping funding levels stable, while slightly reducing the size of scheme deficits.

The movement in gilt yields has been more modest which, along with better collateralised LDI portfolios, has ensured that there was no repeat of the dramatic events post the October 2022 mini-budget. 

The Budget’s impact on pension schemes will continue to evolve as markets digest fiscal policy changes and the BoE adjusts its monetary policy in response to inflation and growth projections. With future rate cuts still anticipated, albeit at a slower pace, and sterling showing resilience, pension schemes can expect further but measured impacts on their funding and asset values.

The bottom line

While the Budget brings broader economic shifts, the direct implications for pension schemes remain modest, with funding statuses appearing resilient. The ongoing coordination between the Treasury and the BoE suggests a supportive environment for schemes navigating these changes. Further updates will provide a clearer picture as these fiscal and monetary policies unfold.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.