This week I wanted to once again zoom out and try to look at the big economic picture and “tell the story” that I’ve been seeing unfold over the past 5 or 6 months. A fair few things have changed in 2021 and the pace of these changes is something that economists and commentators generally are not really used to dealing with. We’ve had a reminder that bear markets act much faster than bull markets with the crypto downswing this month, and this is almost always the case; however, the bull markets are faster than they’ve ever been before (by some way) because of how quickly positive and negative news sweeps across the nation, and of course the magnitude of changes given the severity of the response to the pandemic generally.
I’ve written extensively about inflation this year. Let’s first of all make one distinction very clear – the difference between inflation for inflation’s sake, and inflation as a part of a healthy, growing economy. It should be blindingly obvious that the 2010s was not a great decade in economic history. Of course there was a backdrop of a significant crisis, and pieces had to be picked up. The pain was numbed with a number of measures that “kicked the can down the road”, setting a precedent for economic policy that is certainly still prevalent today. This wasn’t necessarily the worst idea in the world (although it went on for too long in the 2010s), but it did mask the true impact of the Global Financial Crisis of 2008-9.
Inflation wasn’t a symptom of the recovery per se – more a symptom of the incredible drop in base rates that occurred in March 2009 down to the then historic low of 0.5%. RPI in 2011 was 5.2%, after a 2010 figure of 4.6% which showed just how much tolerance the central bank had for the monetary policy measures that they could deploy and how far away from the inflation target of 2% they were prepared to drift. (It was, in fairness, on the back of a -0.5% move in RPI in 2009 also – and deflation is so much more damaging to an economy than inflation, it is relatively easy to understand the logic without going back and reliving the moment). The 5.2% was the biggest number since 1991 (on the back of another crash and resultant measures taken at the time).
The purple patch of the 2010s was really 2013-15 – the only 3 years where our now-anaemic growth rate topped 2% as an economy. Things were already on the way down by the time we reached Brexit referendums and some (at the time) surprising election results throughout the world. This is not seeking to pick a side politically – simply to point out that markets do not like uncertainty. There is also a part of cheap credit (really cheap credit) that stifles growth somewhat – raising money very cheaply for large companies should in theory have led to large capital investment, but instead meant that swapping equity returns for debt returns was very fashionable and lucrative for the top executives, and share buybacks (which lower the number of shares in circulation and drive the price upwards) were commonplace pre-Covid. The idea that this signalled a company “out of ideas” seemed to be shelved since “everyone was doing it, so why don’t we”. Covid stopped this in its tracks for a while but with cheap, easy money washing in the corporate system it seems likely to be a trend that returns in the post-pandemic world.
The inflation spike since 2011 has been at nearly 4% (3.6% in 2017 is the largest quoted annual figure). This was more symptomatic of the Brexit referendum – sterling dropped significantly soon afterwards, shocking the market by depreciating nearly 20% – because as a country we import far more than we export in terms of goods, this shocked prices upwards as the currency differentials worked their way through supply chains. We’ve this month seen April 2021 quoted at 2.9% inflation, the highest since mid-2019. “On the back of a very low rate in 2020” many will cry – yes, it was flatter in 2020 but not negative like 2009, and April 2020 was a 1.5% increase on April 2019. A lot of this has been caused by supply chain disruption, again, rather than a healthy economy – there are the one-off stories such as the Suez Canal “traffic jam”, but many more stories of not enough containers being available, cement not meeting demand thanks to high speed rail, and commodities mills/mines/fields not yielding what they would have done because of decisions taken in April/May 2020 which affect production in the next year. Anything that is seasonal works on a longer cycle, ultimately!
It is helpful to look at the 2010 and 2011 rates, because it reminds us of the tolerance that the central bank might have in the face of rising prices. The Bank uses CPI (which tends to be lower) rather than RPI – I’ve never been a big buyer into the argument about CPI being “superior” to be honest – many people feel that the true rate of inflation is higher than either of the indices suggest, although some of that is because they don’t bear in mind the deflation that does go on in some sectors such as technology-related ones, phones and computers and screens take up so much of our time these days, their long-term price path is somewhat ignored (yes, phones go up in price, but tend to replace more and more things as they do so, so a phone today is doing what 6 or 7 things were doing in 2010 for people, for example). Also cheaper and cheaper smartphones have been coming to market for some years, and advancing in what they can do – so substitute goods are out there.
The Central Bank actually changed the inflation target from 2.5% (when they used the RPI) to 2% when they switched to the CPI in 2003. I am always wary of switches because something sounds and looks better (even though the merits of CPI over RPI could be made a case for). CPI itself touched over 5% in 2011 at one point, so there is not a lot of difference in the analysis above anyway, even if we were sticklers for the definitions. CPI hit around zero in mid-2015 which shows you when the “purple patch” described above lost pace, and the economy drifted through the latter half of the decade.
This trip through the last decade hopefully tells you a little about the number of different factors that do affect inflation in the real world. It just isn’t as simple as “healthy economy, healthy inflation rate”. It also tells you just how far there is to go, as yet, before we might see rate rises required because of the performance of inflation.
My bigger picture fear, here, is that the economy is sleepwalking and could continue that for some years. Grants have been a lifeline for companies, but many of those companies should likely have gone bust and have survived by luck, not judgment. This is highly inefficient and messing with the market rarely has a net positive effect, because we simply don’t know better than the market, in aggregate. If we are sleepwalking towards the next disaster, then inflation as a symptom of a healthy economic growth pattern seems unlikely. I’d love to think it might be there (rather than as part of a bounceback boom style arrangement) – and I have pointed a number of times to the roaring 20s on the back of the Spanish Flu and the Great War – there could and should be an element of this, but the demographics in today’s world look very different to those of the 1920s. As a very broad brush statement, I am seeing younger people more bullish about spending their saved ££££ from the past 14-15 months, and older people still being considerably bearish. And at least once a week I am surprised by someone who is still “Covid-nervous”. Whether we frame it like this or not, we’ve all done our own internal risk assessments and the results are still extremely variable across the population (or certainly amongst the people that I speak to!). Of course, we also all think we’ve got it right!
So – if inflation isn’t sustained by continued economic growth, then where will it go and what will it do? There is still a larger issue with the seduction (at the Governmental level) of inflation to solve some of the problems created by a much larger debt pile. An incredibly low rate of interest for new, issued bonds, combined with shorter maturities (which increases sensitivity to the base rate) is a problem which translates in real numbers to £21bn per year per 1% of interest rate rise (based on a model which is looking 4-5 years in the future, from the office of budget responsibility). Sensitivity to the interest rate has gone up due to the nature of the asset purchasing by the Central Bank. Translated into plain English – this means more risk, not less.
Inflating that debt away is more than helpful. Rishi has, already, without any consequence at all, put in the “Carbon Monoxide” part of what was otherwise a solid budget of 2021 – frozen tax thresholds. It seems now very obvious that we are seeing and will see some short term inflation, because of many of the factors already discussed – this I am not seeing anyone realistically dispute. However, this feeds through into higher prices and thus higher wage demands (minimum has already been moved up c. 2.2% this year as well) and whilst expectations look reasonable from people at this time for wage increases, if there is no major unemployment at all then this will likely change (the bank are now saying under 5.5% is the number, and figures moved in the right direction this month, which suggested 4.8% was the rate, down from a 5.1% peak). Some are still expecting a furlough drop-off “bloodbath” but this is just not what I am seeing as an employer and business owner – many have got other opportunities, full time jobs, and many new businesses are opening up. There is undoubtedly some spare capacity in the economy and home schooling has still weighed on some job prospects and opportunities also – but this will work its way out without major impact from hereon in, in my view. A relatively stagnant 5% rate could well see its way through 2021.
These tax thresholds, I will remind you, are frozen until 2026. If we did run at 3-3.5% inflation (the spot curves have continued to climb quite dramatically this month when looking at implied inflation, and the actual average expected over the next 2 years is touching 4%, although I would expect 3.5-3.75% to be closer to the truth) – the spots for the end of the tax year 2025-26 are suggesting about 3.5% which I would knock 25-50 basis points off, so 3-3.25% looks fair – The £50,000 higher rate threshold today would be equivalent to paying it at £42,610 today. That is a 15%+ erosion in purchasing power, hence the Carbon Monoxide analogy – more brutal than even the hardest treated public sector workers in the austerity period of the 2010s.
Is this sustainable? Politically, probably. It is so hard for the average voter to put their finger on WHY this is happening – and let’s face it, most people have more than enough going on in their lives to understand the nuances of inflation and resultant purchasing power. They will feel something. That in itself will lose a “feelgood factor” – but with speculation on when the next election may be anyway, it may not have done enough damage by then to make a difference, particularly if the next election is called on the back of a “Boris bounceback boom” or similar pithy phrase.
The one parallel you could certainly draw with the response to the 2008-9 GFC is that the people will end up paying, one way or another!
So what of the real worry for property (and realistically, all) investors – the base rate? The Central Bank has, as discussed, moved away from discussions over negative rates. I see this as significantly positive, because, despite press statements otherwise from the Bank, there’s nowhere near enough evidence to suggest these are particularly helpful for economies stuck in a ZIRP (zero interest rate policy) environment. The current forecasts are now 0.1% in 12 months time, 0.3% in 2 years, and 0.6% in 3 years.
There’s clearly a willingness to do things very slowly as well, which speaks volumes about the interest rate sensitivity issue discussed above. 10 basis points may well become the new normal until we get back to somewhere near 1% (which still feels like where we might be in the late 2020s, to me). My own predictions have changed from not getting to 1% by 2030 to us getting there at some point in the 2026-27 sort of area (before we go into another recession, maybe?) – although I do think there’s an even larger chance of a more elongated cycle than the last one, which was 18-24 months overdue (I will remind readers that there were many predictions of a 2020 recession well before the pandemic, and something was quite likely to be a trigger event, although, like always, we could not see it coming).
Regarding furlough – it is worth reproducing the Bank of England’s current view on the situation: “During Q2, an average of around 2¾ million employees are expected to be furloughed. That number is projected to decline to an average of ½ million during Q3. Most of those employees are expected to return to work when the scheme ends, given the expected near‑term recovery in activity, so unemployment is projected to increase only slightly” – this is very much in line with what I have been saying on the subject over the past 6 months or so.
The news since the report, in the past 72 hours or so, has been somewhat negative. There is a lot of hype around the so-called “Indian variant” of Covid. Cases up 25% week-on-week is worrying, although nothing like as bad as some of the figures that have been seen throughout (and starting from a lower base). Some increase had happened the week before following the May 17th re-opening also. 33% efficacy for Astrazeneca first-time-jabbers is also a particularly weak figure in Covid terms (although we accept 30-50% efficacy in the annual flu vaccine, interestingly enough) – the benchmark has of course been set much higher.
However, there are solid responses in terms of local vaccinations, surge vaccinations and the like. The true link between the “new vaccinated world” and the hospitalisations, and resultant deaths, is not yet known and the next 2 weeks will be significant. The Government has not communicated well with areas that have problems – these “Covid wobbles” are likely to characterise 2021 and simply one of the bumps in the road I’ve been talking about for this year.
In other and unrelated news (but as we approach the first stamp cliff/taper) – auctions have seen some further unsold stock this week. Many thanks to one reader who last week pointed out a stat that I had missed – a couple of auctions hit over 30% unsolds in the week before. In the internet auction world, this is very weak indeed. Remember, houses have far greater visibility and data than they had pre online auction being the norm. They don’t offer what won’t sell, keeping their percentages falsely higher (not enough people registered). It might be fair to suggest that 30% is 2019’s 40% unsold, which was a poor result back then. I’ve seen a few lots transact this week and rather than thinking “good luck with that, you are going to lose money” I have been thinking “yes, I can see why you would pay that for it, will be an OK little buy, that one”. This tide seems too early to be much to do with the fact that SDLT is looming back into the picture, and the vast majority of resi auction lots transact below 250k anyway, of course.
The auction market has long been a favoured indicator of the overall market sentiment. I did also consider one thing that I’d normally call the “august effect” although it tends to happen as soon as the schools break up. I’ve been surprised (not sure why, reflecting on it) about how many people have been away post May-17th allowing travel/making it “not illegal” to go abroad (wow, they really need to work on their marketing, don’t they?). This almost always quietens down the auction market – yet another factor that has moved/can’t be relied upon in the intra-covid world as we transition to the post pandemic purchasing period (PPPP, further suggestions welcomed).
This must be good news for some who are hoping for some respite. It might be good news overall, as we could do with some pace being taken out of the market – the longer the recent boom, the more worrying it gets. I have said before that I expect significant fallthroughs on 1st July and very soon afterwards, long chains are in significant danger at that point and there will no doubt be chain-break/chain-saving deals to be done. Be on your toes!
The language from the Central Bank is still quite consistent around inflation – inasmuch as they see this as a transitory period. The spot curves suggest something else, and whilst the Bank are happily ignoring this (or, more accurately, interpreting it in their models as having a higher risk premium being demanded) – and they are very careful about the language that they use in general, as one or two words in a Federal Reserve or Bank of England statement WILL move a market quite considerably – even the interpretation of the mood makes a difference in today’s world – but there seems to be a fair argument for the transitory suggestion.
Is it therefore fair to apply this logic to the property market? Maybe. A transitory rise, because there has been so much transitory demand – home workers need bigger houses. People want more space in general. Households are motivated to get smaller by the pandemic – multi-generational living has had a cost, in lives, unfortunately as you get into the data. These facts are enough to change trends on a permanent basis or at least provide a shock to demand curves for accommodation. Meanwhile, city centres with a glut of flats in development look set for a real wobble, at some stage.
This demand may not cool just yet, however. The zoopla report this week suggested supply was comparatively back to normal. This is good news, and perhaps not surprising – many are more bullish about the end of the pandemic (if it is the end…..) – and also, it is likely to see quite a few try to cash in on the rising market. Demand, however – if there are still many worrying about their job security, AND if that job does prove to be secure as we go through the year – demand is likely to find more support on this basis. And I still haven’t, as yet, rules out a stamp duty reform…….the receipts for stamp duty have not suffered quite as much as some might have expected throughout all of this.
Zoopla have predicted 1.5m transactions throughout 2021. We have seen about 503.5k transactions in the first 4 months on govt data, including 173k transactions in March before what most people thought was the stamp duty deadline. This 1.5m looks unrealistic to me, and I would think 1.25m would be closer (this is still positive compared to an average year of 1-1.2m). Non-residential transactions look to have returned to much more normal levels, already, and the commercial market looks relatively stable at this point. This is another manifestation of my “bumps in the road” prediction.
So what? If you’ve found the last few months particularly testing, then alongside making sure you have a good break on tomorrow’s Bank Holiday, consider redoubling efforts over the next 6 weeks – that next deal is out there, and just remember to cost your materials and labour appropriately – I am still expecting lots of mistakes coming back to market in Q3/Q4 this year with half-finished projects on offer.
If I’m anywhere near correct with some of my predictions, demand should remain relatively strong, supply will be strong because many that have held off will now come to market, and the two might balance each other out for an equalization of pricing or a blow-off of a few per cent (when the stamp duty is factored back in, as well). But pockets of bad news will keep fear and doubt in the mind and it will be easy enough to defer that move for “one more year” as well. Job stability news will come too late for some to consider moving in 2021 and further deferrals will be seen (perhaps to balance out some of the bringing forward of transactions that we’ve seen thanks to the stamp holiday).
Rates don’t look a medium-term worry just yet, although re-gearing now still looks very attractive indeed as fixed rates seem unlikely to get much lower at this point. One thing you can be assured of is that I will be keeping a very close eye on things, and reporting back each week!
Over the last fortnight the supplement has got me into some fantastic conversations with old school friends, university colleagues, and others that I’ve known for far less time. I appreciate the messages, comments, likes and shares every week. A quick plug for our Partners in Property event we will be running on June 26th – tickets are on sale now and we are very much looking forward to a face to face meeting at a great venue, with, of course, Covid-sensitive measures in place! Keep on trucking folks…….