Recession narrowly dodged
The latest raft of economic data has painted a mixed picture for the UK economy with a recession narrowly dodged. Trade and business continue to face challenges and recent concerns of global financial fragility will only add to these. But with blue skies appearing, the days getting longer and temperatures gradually rising Spring has eventually arrived and with it perhaps a sense of cautious optimism.
Has inflation peaked?
There are some signs inflation may have peaked and latest forecasts from the Bank of England and the Office of Budget Responsibility (OBR) both expect inflation to fall sharply this year, reaching circa 3% to 4% by the fourth quarter of 2023. Both also anticipate the rate will return to the 2% target by early 2024.
That said current the high rates we are experiencing do seem to have been stickier than was initially anticipated with the consumer price index rising by an annual 10.1% in March, according to the Office for National Statistics (ONS), above a consensus projection of 9.8% in a Reuters poll of economists. This is a slight dip from the unexpected increase seen in February of 10.4% which broke three consecutive months of declines since October’s 41-year high of 11.1%. Pay growth in 2022 was strong by historic standards although well short of inflation.
Cost of living
The office of budget responsibility report that pay is expected to remain strong in 2023, but will continue to lag inflation. As a result, by the end of 2023, a typical UK household will have seen 3 years of falling “real” incomes by the end of the year, so the cost of living will continue to bite. The consumer outlook will therefore remain very difficult and the result is most people will take a “defensive” approach to spending decisions.
Outlook on interest rates
There may also be some positive news in terms of interest rates since there are signs that the Bank of England is becoming less hawkish in its outlook for possible further rate rises. The Bank governor Andrew Bailey said recently:
“We were really a bit on a knife edge as to whether there would be a recession… but I’m a bit more optimistic now,”.
In a recent blog from the International Monetary Fund (IMF) predicted that interest rates in major economies may fall in the future as a result of low productivity linked to an aging population. It says increases in real interest rates are likely to be “temporary.” After adjusting for inflation, the implication is that a more normal real rate is close to zero. So, assuming inflation settles back at its target level of 2%, that is consistent with Bank of England base rates around 2% to 3%, rather than above 4% as now.
“When inflation is brought back under control, advanced economies’ central banks are likely to ease monetary policy and bring real interest rates back towards pre-pandemic levels.”
But there is a rather large caveat in the analysis in that it will apply only after the current climate of high inflation has ended and furthermore governments will need to keep their borrowing under control. The report says;
“post pandemic increases in interest rates could be protracted until inflation is brought back to target”.
It seems the markets are pricing in further rate rises potentially up to 4.6% by August this year before falling back over the next five years to circa 3%, but a lot will depend on how quickly inflation falls in the coming months. There are concerns wage growth may increase inflationary pressure. But on the positive side the economy has proven to be somewhat more resilient than forecasted which could suggest interest rates may not need to rise much further.
Outlook for borrowers
So, what does this mean for borrowers? With inflation forecasted to drop, thanks largely to a fall in wholesale energy prices, fuel, and the cost of some imported goods, this will remove the core reason for the base rate rising.
In addition, many people wrongly assume that both savings rates and mortgage rates are linked directly to the BOE base rate. When in reality, future market expectations for interest rates and banks’ funding and lending targets and appetite for business are actually far more important. Market interest rate fluctuations are reflected in swap rates. A swap is essentially an agreement in which two banks agree to exchange a stream of future fixed interest payments for another stream of variable ones, based on a set price.
Current swap rates suggest that interest rates will be lower over the coming years, but it is unlikely they will return to the historically low levels we saw until recently. We would also expect any fall in mortgage rates to be slow and gradual.
The cautious economic optimism is reflected in the housing market as sentiment continues to improve as we head into summer and as the uncertainty caused by the mini-Budget last autumn continues to subside. Recent data published by On The Market show that 71% of home buyers surveyed last month said that they were confident that they would purchase a property within the next three months, compared to 69% in February.
Transaction levels are down but this isn’t necessarily a portent of doom that some observers have been predicting. Rightmove report that the level of sales agreed are still 18% behind last year’s “exceptional market,” but are just 1% behind March 2019. So, the market seems to be stabilising to one nearer normal rather than the frenzied levels we saw post pandemic. What is interesting is that it is the first-time-buyer sector leads this recovery, with agreed sales now 4% higher than in March 2019, while the second-stepper sector remains 4% behind.
Average house price inflation has certainly slowed with Rightmove reporting the average price of a property coming to market has risen by just 0.2% in the past month. We do not subscribe to some of the more sensationalist “Click Bait” type headlines prophesising doom and gloom with some predicting falls of up to 30%.
As the saying goes “bad news sells newspapers” but it does seem that pessimism is a national obsession and perhaps we should really be focussing on realism! Despite the testing conditions in which the market has had to operate, it has proved itself to be remarkably resilient in recent months. We would be foolish in the extreme to seek to claim that the ongoing economic uncertainty isn’t having an impact. But rather than dramatic falls in values the market seems to be undergoing a reset towards a healthier and more sustainable level. This no bad thing after a couple of years of unprecedent and unsustainable growth fuelled by the pandemic and historic low borrowing costs.