Chief Economist’s Weekly Briefing – Hawks and hikes

Bank of England policymakers turned more hawkish last week, raising rates by an even greater amount and refusing to offer any pushback to markets that are pricing further rate hikes in coming months. Mortgagers are at the receiving end of higher interest rates. Across the wider economy tremors are already being felt, in areas like construction and business activity. Elsewhere, the story is no different, with a slowdown materialising in the US and the Eurozone.

Whatever’s necessary.  That’s how BoE Governor, Andrew Bailey, summed-up the MPC’s thinking as it raised Bank Rate by a larger-than-expected 50bps, to 5%. Recent economic data—from stubbornly high CPI to strong job & wage growth—had triggered widespread concerns that high inflation is becoming embedded in the UK. Policymakers responded hawkishly. The 7-2 vote in favour of raising rates to mid-2008 levels signals determination to rein-in inflation, whatever the cost. So too do the accompanying minutes, which state that further tightening will depend on “evidence of more persistent pressures” and do little to disabuse market expectations that rates could peak as high as 6% by next year.

Stuck. The half-point hike followed another unwelcome inflationary surprise in May. CPI inflation remained stuck at 8.7%, embarrassing economists and financial markets as domestic price pressures failed to ease. Rising prices for airfares, second-hand cars, recreational & cultural goods contributed to the surprise. Despite falling petrol and diesel prices, and some modest easing in food price increases, the underlying picture is deteriorating. Far from slowing, there was a further acceleration in core CPI (excludes food, energy & volatile items) and services CPI. Both measures breached the 7% barrier, hitting 7.1% and 7.4% respectively. A wage-price spiral may now be in motion. Cue tougher action.

Ambiguous. June’s PMI paints a mixed picture of whether the MPC has done enough. The UK’s composite flash index fell to 52.8 in June from 54.0 in May. Both services and manufacturing contributed to the slowdown. The reading is technically consistent with QoQ growth of 0.2% in Q2, but in reality an anticipated downturn in construction and public sectors (both excluded from PMIs) is likely to leave activity unchanged. Some good news on prices:services output prices balance declined to 60.1, from 60.5—consistent with  the “core services” CPI slowing to about 5% soon, from May’s frantic 9.0% pace.  While this presents a case for pausing monetary tightening, the MPC hasn’t been clear how much progress it needs to see before taking a breather.

Resilience. That’s what economic activity in the UK demonstrated.  Consumer behaviour indicators showed strong activity in the latest week, with overall retail footfall at 103% of the level of the previous week. Consumer confidence improved for the 5th consecutive month in June, rising 3 points to -24, highest level since Jan ’22. Moods appear to have been assuaged by the strong labour market and lower energy prices. Further, for the first time this year, energy prices were not reported as the top concern for business’ over the next month. But the latest interest rate rise by the BoE could weigh on confidence in coming months as the cost of financing home loans rises.

Lottery of pain. Back when the BoE was last seriously raising interest rates, there were almost 12m mortgages in the UK and more than half of balances were on variable rates. Now there are 1m fewer and 85% are on fixed-rate deals. The BoE finds itself needing to inflict more pain on the relatively few mortgagors whose deals are soon refinancing to generate a timely reduction in aggregate demand. Calculations by the Resolution Foundation show that due to higher interest rates, annual mortgage repayments are on track to be £15.8 billion higher by 2026 compared to Dec’21. Annual repayments for those re-mortgaging over the next year are set to rise by £2,900 on average. The bad news – for the government as well as households – is that three-fifths of the mortgage pain is still to come, with almost £5bn set to hit in election year.

Winter’s coming. UK house prices rose by 3.5%y/y in April according to the Land Registry, taking the average house to a quite astounding £286,000, £9,000 higher than a year previously.  But with the summer solstice passed, the cycle of seasons leads inevitably to winter. A metaphor particularly apt for the housing market. Much has occurred since April, not least the belated acceptance by UK authorities that inflation is stickier than summer honey. Mortgage affordability is being squeezed. This we know. What’s less certain is whether the housing market goes into deep freeze, like during recent downturns, or folk decide to sell-up.

The wrong sort of record. Monetary policy was hogging the headlines this week but an unfortunate record was broken on the fiscal front too.  The UK’s net debt to GDP ratio topped 100% for the first time in more than 60 years.  The most recent causes are big increases in spending driven by energy support schemes and the costs of uprating benefits (including state pensions) to keep up with inflation.  That adds up to a deficit running around 5% of GDP, fuelling some of the fires that monetary policy is having a hard time trying to put out.

Expected. Last week’s data suggest that advanced economies have begun to slow as central banks battle inflation. Following two consecutive quarters of decline in the euro area, the latest PMI data raised concerns about further deterioration. Growth in both services and manufacturing business activity fell to a 5-month low of 50.3, from 52.8 in May. Manufacturing remained a principal area of weakness and is in downturn globally. Services were also weak, while price pressures were cooling. Across the Atlantic, US business activity fell similarly, hitting a 3-month low of 53.0 in June, from 54.3, admittedly still in expansion territory. Services growth eased for the first time this year. While the Fed took a break from raising rates in their last meeting, worries remain as to whether aggressive tightening over the past year could ultimately trigger a recession.

Leave a Reply