Kroll is increasing the Canadian and UK normalized risk-freerates from 3.0% to 3.5% as of September 1, 2022
Executive Summary
Kroll regularly reviews fluctuations in global economic and financial market conditions that may warrantchanges to our equity risk premium (ERP) and accompanying risk-free rate recommendations. The riskfree rate and ERP are key inputs used to calculate the cost of equity capital in the context of the Capital
Asset Pricing Model (CAPM) and other models used to develop discount rates.
On May 17, 2022, Kroll increased the Canada and UK normalized risk-free rates from 2.5% to 3.0%. At
that time, we cautioned that continued inflationary pressures, which were exacerbated by the RussiaUkraine war, could cause further rises in long-term inflation expectations, which would lead us to revisit
our normalized risk-free rate assumptions. Indeed, based on newly updated long-term inflation
expectations for Canada and the UK, Kroll is increasing the Canadian and UK normalized risk-freerates from 3.0% to 3.5%, when developing respectively CAD- and GBP-denominated discountrates as of September 1, 2022 and thereafter, until further guidance is issued.
We are closely monitoring changes to long-term inflation expectations for Germany and the eurozone. Atthis time, we are reaffirming the Kroll normalized risk-free rate for Germany at 2.0% whendeveloping EUR-denominated discount rates, but this could also change in the near future.
Support for the Change in GuidancePreviously, the long-term average of government long-term bonds yields was an important input indeveloping our normalized risk-free rate conclusions for both Canada and the UK. We believe that giving
some weight to long-term averages was especially appropriate when the Bank of Canada’s (BoC) andBank of England’s (BoE) monetary policies were very accommodative, and inflation was close to therespective official targets (the BoE targets an inflation rate of 2.0%, while the BoC targets a 2.0% midpoint within an inflation-control range of 1.0% to 3.0%). However, given the rapid rise in inflation
expectations and interest rates, we believe that long-term average yields of government bonds induce adownward bias, and therefore we are placing a lower weight on this method when arriving at ournormalized risk-free rate conclusions.
For perspective, the annual consumer price inflation had averaged 1.8% in Canada and 2.0% in the UK
over the 2011‒2021 period on a rolling 12-month basis. By contrast, in recent months inflation hascontinued to surprise on the upside—reaching multidecade highs—with the recent Russia-Ukraine war
exacerbating inflationary pressures, especially in energy prices. In addition, the long-term inflation
expectations for Canada and the UK increased considerably in the last few months. The median longterm inflation expectations for Canada increased from 2.2% at the end of December 2021 to 2.7% at theend of August 2022, while for the UK the expectations surged from 2.3% to 3.5% over the same period.
This significant change in outlook precipitated an important shift in both the BoC’s and BoE’s monetary
policies stance relative to December 2021. The two central banks adopted a more restrictive stance by: (i)raising their policy interest rate several times and signaling more hikes to come; and (ii) ending theirquantitative easing (QE) programs.

These recent trends have led to a significant and very rapid rise in short and long-term interest rates inCanada and the UK with no signs of abating any time soon. For example, the Government of CanadaBenchmark Long-Term Bond yield went from 1.7% on December 31, 2021 to 3.0% on August 30, 2022.
Similarly, the 20-year British Government Securities yield went from 1.2% on December 31, 2021 to 2.9%
on August 25, 2022. Long-term interest rates may finally be reverting to levels considered to be “normal,”as attested by the rapid acceleration in the rise in yields over the last several months and the dramaticchange in the BoE- and BoC-projected trajectory for policy interest rates.
For the underlying data support for the latest guidance for these countries, click here.
Please contact the costofcapital.support@kroll.com with any questions.