A long, healthy and comfortable retirement is an aspiration most of us share. The graph above does make me wonder though whether I might be able to enjoy my state pension in the late 2040s… It shows the old-age dependency ratio which is the number of pensioners in the UK for every 1,000 people of working age and the higher the number, the fewer workers there are to support each pensioner. The ratio fell over the past decade with increases in the State Pension age and it now stands at its lowest for 50 years.
However, as the baby-boomer generation reaches pension age and life expectancy continues to rise, the ratio is projected to climb back towards its 2010 peak by the mid-2030s, reaching 329 by 2049. A falling birth rate means (all else equal) fewer workers coming through to share the load: just to hold the ratio at today's level, the ONS estimates the State Pension age would need to reach 70 in the 2040s - just as I get there!
But this isn’t about me – the yield on the 30-year Gilt last week hit 6% and has been regularly hitting highs over recent weeks that we’ve not seen since the late 1990s. While the immediate trigger was fears of stubborn inflation driven by energy prices, investors are also demanding a higher premium to lend to a government which in due course will have to finance increased age-related spending such as pensions, health and social care. Indeed, the Office for Budget Responsibility projects that, without any policy changes, age-related spending could push government debt above 270% of GDP by the 2070s.
But who cares about long-term rates? You’d expect short-term rates (the ones that we probably focus on more as market participants) to fall eventually as the impact of higher energy costs works its way through the system and anyway, the proportion of long-dated issuance has fallen to under 10% from almost 30% only a decade ago. It does of course mean that the UK is increasingly exposed to more volatile short-term interest rates as the Debt Management Office must refinance more frequently, with the market currently pricing in BoE hikes (rather than cuts) over the coming year. The long-end clearly influences the shorter end too: the UK’s 10-year borrowing costs are the highest in the G7 at 5.4% and we’ve seen recent rises in fixed-rate mortgages as they’re priced over gilts.
Today’s long-term rates strongly signal that demographic change coupled with the current policy course make for an unsustainable fiscal environment. Investors are buying gilts today based on their perception of the relative risk of the UK Government’s creditworthiness and that should warn us of the tough structural change that is required to sort this all out. What’s the preferred remedy? Reforming the welfare state and the pensions triple lock, accepting higher borrowing costs or increasing the State Pension age? At this rate, that retirement might be neither long nor comfortable!