Financial Update from Brewin Dolphin - 23 June 2023

June 2023

The Weekly Round-up

Friday 23 June 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, explores the drivers behind higher-than-expected UK inflation, and discusses the implications of the Bank of England’s rate hike.

When key economic data are published, some market moves are entirely intuitive, some are expected despite seeming unintuitive, some are unexpected but can be post-rationalised, and some seem entirely unpredictable.

UK gilts had a grim start to the week, underperforming global bonds markedly. There were no data, speeches or announcements to explain the move, but we knew the market’s focus was on inflation and interest rate news coming later in the week and that there were reasons to fear the worst. On Tuesday, UK bonds rallied. The move was hard to predict but easy to understand as the higher yields now available will inevitably draw some new buyers into the market.

UK inflation shock horror

Wednesday saw the release of the dreaded UK inflation data, and yields rose as might have been expected.

So what did these data tell us? It felt like Groundhog Day in the way that inflation was above expectations for the fourth month in a row and, like those previous months, by a significant margin. Short-term inflation forecasting has never been as difficult as this and the private sector economists are proving no better at it than the lamented Bank of England.

The breakdown of that inflation was significant. Price increases were concentrated very much in the discretionary spending categories such as hotels and restaurants, air fares and recreation. Within this last category, the Office for National Statistics cited concert tickets as being an unusually strong category. It is hard to record these things correctly as different artists and venues should justifiably command different fees, so comparisons between last year’s Taylor Swift and this year’s Beyonce can be unfair. Glastonbury provides a ready comparison. Tickets are almost 20% higher for 2023 than 2022 (and were bought before the line-ups were announced). I was worried I might be driving this myself, given the unusually full gigging calendar I have this summer, but last year’s Red Hot Chili Peppers tickets were the same price as this year’s, so presumably the younger artists are to blame!

Time for action

The observation about concert tickets and another inflationary category, computer games (which I have less experience of), is that these are sporadic depending upon who tours and what games are released. So while these data support the idea that UK consumers are happy to keep spending despite much grumbling about the cost of living, they could to some extent still be a little distorted.

Two logical paths follow from this dilemma. The first is that the Bank of England cannot risk assuming that these data are misleading. So persistent has been the inflationary shocks that anything short of total resolve would be alarming. The Bank followed through on Thursday, raising rates by half a percentage point against the unanimous consensus of economists who believed a quarter point increase was coming (those predictions were made without knowledge of Wednesday’s inflation release).

Time to get serious

When interviewed after the decision, governor Andrew Bailey was resolute about the need to tackle inflation and, if necessary, trigger some economic hardship along the way. There is no desire to cause a recession, but the raising of interest rates is designed to limit the spare cash homebuyers have to spend on discretionary items. This tone was a great improvement on February’s comments, in which he seemed to tell people not to seek significant pay increases because they might stoke inflation.

Speculation this week about fiscal measures to support borrowers who are struggling with repayments would cut across the actions of the Bank of England, risking even more persistent inflation.

Implications…

The market’s reaction to the shock half a percentage point interest rate increase was a nod of approval (yields changed very little). Very short-dated bonds sold off a little as they anticipated even more interest rate increases could still come. But for bonds maturing beyond two years away, investors saw the Bank of England’s determination as an indication that interest rates will be lower because inflation will be brought to heel.

That’s good news for consumers, but less so for those who are refinancing their mortgages this year. It’s a high proportion, not least because two years ago the government was incentivising home purchases through the stamp duty holiday introduced in 2020 and scheduled to end two years ago this month. Whilst the scheme was phased out, in the end it led to a flurry of deals being done in June 2021, most of which were on two-year terms and will be due for renewal over the coming months.

The pain from this will not be suffered evenly. 70% of homes have no mortgage – a record high share.

Of the remaining 30%, many have very low balances outstanding and will therefore experience relatively little uplift in payments. Of the remaining borrowers, some will have fixed for longer terms. The real pressure therefore will land on those who have borrowed c75% of the value of their property to make a new purchase within the last couple of years. Fortunately, in doing so they will have been constrained by regulation which requires their financial circumstances to be stressed against a mortgage interest rate of 6%. A repeat of housing crashes of old is therefore probably not on the cards.

Meanwhile, somewhere else…

There are bond markets in the world beyond the UK, and their actions have been a little more perplexing.

A Treasury sell-off in the US on Thursday came despite a disappointingly high number of new jobless claims being announced. It perhaps wasn’t shocking and preceded surprisingly strong sales of existing homes. This represented the latest in a slew of improving housing data. We’ve been tracking this for a few months and it could give the Federal Reserve concern. The National Association of Home Builders’ sentiment index is recovering sharply. New housing starts were shockingly strong on Tuesday. Anecdotally the construction sector is still struggling, but an improving secondary market for properties would be helpful in supplementing new buyer interest, especially if labour and materials costs become more reasonable.

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