Economics - Quantitative-easing concerns

Moves by the UK government to increase liquidity in the UK economy through the Bank of England (BoE) acquiring gilts and high-grade corporate bonds - quantitative easing - could miss their target because the majority of these assets are held by buy-and-hold investors such as insurers and pension funds, according to a senior figure in the UK insurance sector.

On 5 March the BoE announced that despite slashing interest rates to an all-time low of 0.5% it was in danger of undershooting the long-term 2% inflation target, so it intended to buy-up gilts and corporate bonds directly from banks - with the intention that this would provide a trickle-down of liquidity to the high street.

"Asset purchases ... should boost spending. For example, if a pension fund or life insurance company sells an asset to the bank this boosts the amount of money in the economy,", the BoE says in a statement.

However, Mark Wood, chief executive of London-based bulk purchase annuity provider Paternoster, questions the logic of this stance and instead argues that neither group would be in a position to sell, and the true beneficiaries of quantitative easing could be offshore investors.

"Insurers are major holders of both gilts and bonds. But because these assets are used to cashflow-match their liabilities, if insurers sold them under the auspices of quantitative easing they would need to buy them straight back. This would of course be self-defeating for the BoE. Some have speculated that foreign-exchange movements suggest that there has been a large influx of capital from offshore investors in the run-up to this development, so that ultimate benefit of the bank's policies could be found outside of the UK."

Other insurance players were more optimistic about the potential benefits of the BoE's actions Chris Wales, chief executive of fellow bulk purchase annuity provider Lucida, argued that a positive impact could already be discerned on the bond markets.

"We have already seen a tightening in the gilt price, so clearly quantitative easing is having an impact. But it is difficult to know how much of this change is related to actual government intervention and how much is simply market expectation of further intervention.

"According to market reports, the BoE has already said it will buy top-quality corporate bonds in tranches of £3 million to £5 million and I expect to see the benefits of this move down the waterfall of credit and provide liquidity to other parts of the market. But what the timeframe is for this process is very difficult to say."

There may be differences of opinion on the potential impact of quantitative easing on the broader economy, but there was unanimity among insurers that changes in the value of gilts would not - unless in very extreme circumstances - affect the solvency levels of UK insurers.

John Occleshaw, executive director at Potters Bar-based Canada Life, said that the liability-matching attributes that Wood singled out as potentially undermining the success of quantitative easing meant that solvency issues should be sidestepped.

"Assuming that insurers' books are well-matched, when the Bank of England's intervention drives-up prices of gilts, the asset price will go up but the yield will fall. So although we will be discounting using a lower yield this will be cancelled out by the change in asset price, meaning there will be no major impact."

Occleshaw did say that the reduction in yield had already been felt in the annuity market, further depressing the returns for vesting annuitants, with prices increasing by an average of 3%. "So pensioners have now been hit by a double whammy - the value of their assets has fallen and the costs of the annuities these assets will buy have increased. People are really suffering."