Clive Fortes, Partner, Hymans Robertson, comments:
“Today’s confirmation that inflation remains stubbornly high is another red flag for pension schemes after last week’s QE announcement. The typical FTSE 350 company has been allowing for RPI inflation to run at 3.5% p.a. and CPI at 2.8% p.a.. If RPI persisted at over 5%, FTSE 350 companies would need to find an extra £7bn to meet the higher costs.
“Fortunately, markets are predicting inflation falling over the longer-term. Prices of long-dated inflation-linked investments have been coming down rapidly in the last month. Long-dated inflation is currently priced a little over 3% which is the lowest since the financial turmoil of early 2009 and much lower than the current 5.6%. Lower long-term inflation alone could shrink FTSE350 pensions deficits by around £25bn, but other financial pressures like higher corporate bond yields will dampen the benefit under IAS19.
“Looking ahead, companies may be able to hedge their pension inflation risks by capitalising on some attractive opportunities. Today’s high short-term inflation is expected to drift lower through 2012. Long-dated inflation should have this prices in already, but market sentiment is hard to predict given uncertainties over economic growth and the political solution for the Eurozone. One thing is certain, if hedging inflation does get cheaper there will be a rush of companies and pension schemes looking to capture the opportunity and only those who are ready and act quickly will get their hedging done.”
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