Title: How will the cut in the bank rate affect annuity rates?

Author: Billy Burrows

Added on: 08/11/2008

Last Thursday the Bank of England made a dramatic 1 1/2 percentage point cut in UK interest rates. The bank rate is now 3%, the lowest level since 1955. At fist sight it might seem than this will result in a similar cut in annuity rates, but on closer inspection, it seems that although annuities are set to fall, the cut may not be too dramatic.

It is important not to confuse short term rates with long term yields. Just because the bank rate is going down it does not follow that long term yields, on which annuities are priced, will fall as fast.

In fact, lower bank rates will heighten concerns about inflation which in turn may push longer term yields higher. Therefore although we expect cut in annuity rates, we don't expect the cuts to be relatively modest and certainly not as dramatic as the cut in the bank rate.

It is also worth remembering that annuities are more closely linked to corporate bond yields than gilts. As the economic downturn continues insurance companies will need to make larger provision for the risk of bond defaults and this will drag down annuity rates.

At present rates are at their highest level for over 5 years so it is probably not a bad time to lock into current rates if you are in a position to do so.

However those who have seen their funds fall in value over the past few months must decide if they want to liquidate their funds now and go for security of an annuity or wait until their funds increase in value before buying an annuity. Getting the timing right is difficult and it could get worse before it gets better.