Low interest rates and pensions crisis creates perfect storm – ASTL

Interest rates are at an all-time low, but prolonged low interest rates may well end up doing more harm than good. What is clear is low interest rates are helping to inflate property prices due to the affordability of high levels of debt and the lack of decent returns from alternative investments.

Our government, as with many other governments and central banks around the world, feels we need to encourage consumers to spend our way out of a potential economic downturn, hence continually lowering the price of borrowing; but it is this very level of debt that may be the cause of the next recession. Even Mark Carney said recently “a consensus is growing that escaping this low-growth low-inflation trap will require a rebalancing between monetary, fiscal and structural policies. The last are the most important.”

At the same time, record low interest rates are hitting pensions. Pensioners who have saved for retirement are getting ever lower returns on their money. More worryingly, an increasing number of firms with final salary pension schemes are finding they have shortfalls, while the pensions deficit has reached 40% of GDP according to economist Alan Capper who spoke at the conference. The result may well be either diminution in dividend payouts as firms shore up their pension funds, alternatively, they will need to reduce pension payouts or increase the age at which payments begin. Early retirement may become a thing of the past as many can no longer afford this option.

The Bank of England is seeing first-hand the effect of its interest rate cuts on pensions as it has massively increased contributions into its own pension scheme recently, something not possible in the private sector. This, of course, is being funded by the taxpayer, creating a double whammy for those forced to work longer.

This is changing the shape of the property lending market. The chief economist of the Bank of England recently suggested that people are better off investing their money in property rather than pensions. This is not likely to do anything to dissipate the demand of people for buy-to-let investment, despite taxation measures designed to discourage this. It also helps push up house prices making it ever harder for first-time buyers to get onto the housing ladder. This means people tend to take out their first mortgages later, but also means they need them for a longer period of time.

Lenders are responding to this demand for later life mortgages by extending maximum lending age up to as much as age 85. Of course this still relies on meeting affordability standards so, together with the reduced income from pensions, it increases the pressure to continue working for significantly longer than the state retirement age.

Those already in retirement are finding the low interest rate environment means their incomes are lower than anticipated and so they are turning to equity release to provide them with the funds their pension pots cannot.

There looks to be little chance of an early end to this situation. While there may be a boost to lending in the short to medium term, the long term effect of low interest rates, the issues of inadequate pension income and burgeoning debt levels could create long-term problems that may make the credit crunch look like a minor blip.