The current volatility in the UK’s gilt markets should be manageable for UK insurers, says an analyst at Moody’s.
Last Friday, Kwasi Kwarteng, the UK’s new Chancellor of the Exchequer laid out a much-derided Budget that sought to slash taxes for high-earning households in the UK.
Among the changes laid out by Kwarteng were a removal of the 45% additional rate income tax band for those earnings more than £150,000 a year, along with the bringing forward of a cut in basic income tax from 20% to 19%.
At the time, Kwarteng said his Budget had been designed to drive economic growth in the country of 2.5%.
The fallout from the announced Budget was swift and brutal. The British pound tanked in value against the US dollar, falling to its lowest level in history. Such a shift now means that imports into the UK are to rise in price, this coming at a time when fuel bills are skyrocketing by thousands of percent. Inflation within the country is already running at its highest levels in four decades.
The impact of the Budget has also been felt on the gilt markets.
Gilts, which are the low-risk-and-low-reward bond instruments used by governments to raise money to provide services and infrastructure, are currently taking a battering on the international markets, with the yields rising to over 4%. This means that it is far more expensive for the UK government to raise money.
The value of gilts has plummeted. But some contracts require investors to post additional collateral as rates move. This has meant that the UK’s defined-benefit (DB) pension schemes, which generally hold a staggering amount of gilts, have had to quickly raise cash by selling assets.
As a result, the UK’s central bank stepped in yesterday and authorised the temporary purchase of around £65bn of gilts to prevent numerous pension funds within the country collapsing.
In a statement, the Bank said: “In line with its financial stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses. To achieve this, the Bank will carry out temporary purchases of long-dated UK Government bonds from September 28. The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by HM Treasury.”
Even the International Monetary Fund has weighed in, saying: “Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes with monetary policy.”
However, a Moody’s analyst has said that the situation should not adversely affect UK insurers.
Brandan Holmes, the analyst in question, said: “UK insurers’ strong liquidity and robust capital positions, supported by the Bank of England’s intervention in the Gilts market, will allow them to navigate the current volatility and illiquidity in swap and bond markets.
He added: “Many UK life insurers would have faced cash calls to satisfy variation margin requirements on their interest rate hedge positions this week – this would have been most meaningful for insurers with large annuity books – however we expect this to be manageable given their strong liquidity buffers.”
