Why high interest rates can be a blessing for certain British businesses

The bond markets are getting ahead of themselves by anticipating a sharp fall in the Bank Rate for next year.

CPI inflation is down from double-digit levels last year. At 4.6pc, the CPI inflation rate is still more than double what it should be. Although the economy is barely growing as a result, consumers are not showing signs of tightening their belts.

Even the house prices have started to rise.

The labour market will only get tighter if the government follows through on its plans to increase the minimum wage required for legal immigration. The pressure will increase on prices and wages.

The Bank of England has not yet declared victory over inflation. The Monetary Policy Committee will almost certainly leave the Bank Rate at 5.25pc after its last meeting on Thursday.

“I’d be equally amazed if they changed their language significantly on the future trajectory for interest rates. That is, that “…monetary policies are likely to remain restrictive for a long period of time”.

The central bankers’ mantra of the day is “Higher for Longer”.

Investors expect the UK Bank Rate to be cut by at least 0.75% in the next year, a larger drop than previously expected.
It’ll be interesting to see who is right. In the meantime, it’s important to note that not everyone wants rates to fall.

Companies with defined benefit pension plans are another group that benefits from higher interest rates.

The sponsoring company must set aside money to cover any shortfall when interest rates increase.

In the past, very low interest rates were disastrous for many businesses, as they had to use profits to cover deficits that could have otherwise been used to increase investment, dividends, and wages.

Some companies were viewed as nothing more than prisons of their pensioners of the past, with their sole purpose being to feed this leviathan pension fund obligations.

One could say that this is just another symptom of a nation that has become captive to the past. Resources are increasingly being focused on maintaining the old rather than building the future.

The rising interest rates has changed the dynamic so that many companies are now in surplus with their final salary pension funds and do not need to pay any additional annual contributions.

Why? Osler, a business law firm, explains this as follows: “In order to conduct an actuarial value, countless future events have to be assumed or forecasted.

These assumptions include the life expectancy, retirement age, salary increases and interest rates. Actuaries generally discount future cash flow by using a rate that is linked to long-term rates of interest when calculating present value.

An increase in the long-term interest rate would mean that the liabilities or discounted value of future cash flow of a pension scheme would decrease. It could also lead to some defined benefit pension plans having a surplus.

It has. Pensions Protection Fund’s latest “Purple Book” estimates that, on a fully-paid-out basis the net funding of Britain’s 5,063 remaining defined benefit pension schemes has improved from a deficit to £149.5bn. The funding ratio thus improves from 79.2pc up to 111.9pc.

Companies are all over the place gleefully announcing the end of the depressing and frustrating process of having to constantly cough up money to fund pension fund deficiencies.

The accounting might not reflect the actual situation, as it depends on different assumptions, like interest rates.
If rates return to near zero then tomorrow’s surplus will quickly become today’s deficit.

Regulators, however, are very careful to set parameters that will ensure pension funds can always meet their future obligations. i.e. Close to or in fact, surplus.

This is a judgement call, which by definition will be flawed.

If you are one of the beneficiaries, it is a good idea to require pension schemes to reduce their risk so they can in theory always fund future liabilities.

It has had a disastrous effect on the UK stock exchange, forcing an abrupt switch from risky equities to gilts and diverting profits to pension funds. This is not in the best interests of or the UK economy.

Companies who are required to constantly plug pension deficits will not invest in the future.

It is difficult to say how much the new interest rate regime and the removal of the deficit funding obligation will actually help improve the poor record of British business investment. But, it can’t get any worse.

It may seem a stretch, but we’re also re-evaluating the wisdom of locking down – which was widely accepted as a necessary measure in the fight against Covid.

The lockdown may have saved us from the worst of the financial crisis but the consequences of its implementation were very unfavorable. Like lockdown, no cost-benefit analysis was done, and the pros were not weighed against the cons.

In the immediate aftermath, there was a clear justification for quantitative easing at zero rates. But then it became the norm. The Bank of England continued to print money because it was the norm.

Hope that lessons learned. Money with no value will be worthless and destroy the economy.