Mark Carney has finally done it. After months of speculation, the man dubbed an ‘unreliable boyfriend’ by commentators for his habit of leading the market up the garden path finally pulled the trigger and raised the Bank of England base interest rate from 0.5% to 0.75%.

The rise – supported by all nine members of the Bank’s Monetary Policy Committee (MPC) – means interest rates are at their highest level since March 2009.

The dramatic headlines that followed the decision perhaps reflects the symbolic nature of the increase rather than the impact it will have on people’s everyday lives.

Students of interest rate history and those who lived through double-digit base rates in the 1970s and 1980s will chuckle at the excitement created by a 25 basis points interest rate rise.

But for many younger savers 0.75% will be the highest rate they have ever known. And with the Bank suggesting over the longer term people should expect interest rates to rise to 2-3%, it’s worth considering the implications this could have for your retirement income choices.

ANNUITIES

Before the pension freedoms were introduced in April 2015, most people turned their defined contribution (DC) pension
pot into a guaranteed income for life by purchasing an annuity when they retired.

Since then the dial has firmly shifted in favour of flexibility, with two people now entering drawdown in the UK for every annuity purchased.

This reflects the fact people like being able to increase and decrease withdrawals depending on their needs and circumstances, while also potentially benefiting from stock market growth by keeping their fund invested.

It is also testament to the fact that, with interest rates stuck at record low levels, the rates offered by annuity providers have been stuck at paltry levels since the Financial Crisis.

This can partly be explained by the fact insurers have to buy gilts to pay out guaranteed streams of income. Because gilt yields have been at record lows, annuity rates have also been poor by historic standards. If interest rates rise and gilts follow suit, annuity rates should also creep north.

DRAWDOWN

Rising interest rates could also have implications for those who decide to keep their retirement fund invested through drawdown.

As interest rates increase, investors might consider
re-evaluating their portfolios and risk/return appetite. At a basic level, as the Bank’s risk-free rate rises investors might be less inclined to buy shares if the risk-free return on cash (at least in pre-inflation terms) keeps rising.

Rising interest rates could also spell trouble for bond investors. Again, this is because higher interest rates could lure investors back to cash, or at least force bond issuers to offer higher coupons on new bonds to compete, making their current issues (with lower coupons) look less relatively attractive.

Of course your drawdown investment strategy isn’t just based on interest rate expectations. Ultimately the UK base rate environment remains fairly benign by historic standards, so while it is sensible to be vigilant and review your retirement strategy regularly, knee-jerk reactions should be avoided.

Tom Selby, senior analyst, AJ Bell

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