Supplement 12 May 24 – One domino at a time

May 12, 2024

The journey of a thousand miles begins with a single step.” – Lao Tzu, Tao Te Ching (6th century BCE)


Before we get started, I’m delighted to say our next Property Business Workshop is already taking bookings and we’ve only a handful of Super Early Bird tickets left. 


This time Rod Turner and I will be taking on: The fundamentals of property investment. Risk mitigation and control. Relevant investment metrics. Differing secured debt arrangements and loan structures – and – Scaling your property portfolio/business – why, when and how?


Thursday 4th July, in a Central London location (Blackfriars). Super Early Bird tickets are now available – and thanks to the early bookers who make it viable to book a room and organise the event – we reward them with 20% off! There are a few of those tickets still available here: 


Welcome to the Supplement, everyone. All eyes were on the Bank of England to see if the crazy Morgan Stanley prediction of a rate cut would come true. It didn’t – BUT – a domino fell. The vote was 7-2 to preserve the current rate, with 2 voting for a cut. I get stuck right into the Bank of England MPC meeting minutes report later.

Before we get into that, however, our macro starter as always. Last up you know it will be the 5-year gilt and swap yields, of course, but before that – let’s have a chat about the Construction PMI because there was a surprise surge in late April (but – as always – detail is key) – the RICS house price balance –  and we couldn’t leave out the Growth rate of course from Friday morning either, as that will also play into the decision at the next Bank of England meeting in a little under 6 weeks’ time. The game of chess gets interesting from here.

The bonus before kicking off the macro though – the amuse bouche if you will – I also want to make a more regular feature of sneaking in the news from Property Statto Christopher Watkin, the best provider of real-time residential property stats in the game. I think I should be sharing these weekly. 


Re-appropriating his headline once again – “BEST FORTNIGHT FOR THE UK PROPERTY MARKET IN TWO YEARS.” Tale of the tape:


Listings still very strong.

Net sales up 21.4% year on year last week, and 13.7% higher than the 2024 average so far – going well (seasonality, bear in mind, but still…..)

Gross sales up 8.2% on the 2017-19 average.

Market is looking healthily normal at the coal face in spite of the interest rates! The market likely has a good number of buyers who have a rate fixed at below the current best rate since there has been a rise in the past few weeks, so nothing to get overexcited about, but certainly nothing to be worried about either.


Onwards. It’s hard to make enough room for only 4 areas of interest this week on the macro, but that’s the way it is. Construction PMI had to sneak in because it was such an increase on the flash PMI from just 2 weeks before. April printed 53 in the end and I thought “Blimey – have I been underestimating the sector or overstating some of the roadblocks for the housebuilders” – just as this week we seem to have been peppered with articles about the state of play and how to fix it, Shelter’s “demand” for 90k affordable rental units to be built each year, etc. (the problem of course with affordable rent is that 80% of today’s market rent is simply what market rent was about 3-4 years ago – that’s inflation for you)


As always, you have to get into the weeds. You know that by now. The headline in the S&P report was “fastest expansion of construction output since February 2023” but when you get into the sub-headlines: growth led by commercial work and civil engineering, house building declines again in April, and supply conditions continue to improve. Why did house building decline fairly sharply? (remember – it’s one month. Not something to get overly excited about). Sluggish market conditions and elevated borrowing costs. No real news!


OK – the RICS house price balance, then. There was a brief murmur of there being a positive print for April, although that didn’t quite come to pass. Consensus ended up being at -2, and the actual print was -5. The report included reports of flat buyer demand, with a slight softening in near-term sales expectations. Very consistent with what we’ve been seeing in the movement in the interest rates, but April’s pay packets will be higher, and that as yet has not been factored in anywhere, of course….


The next 12 months is still in expansionary territory, according to the survey, but listings continue to rise. Those looking to sell feel they have “waited long enough”. The survey does say that a loss of buyer demand impetus is concentrated in London and the South. Sales agreed at +5 was the first positive print since early 2021, which is good to see – and congruent with Mr Watkin’s reports of a buoyant market according to SSTC figures and real-time data. 


Whilst the next 12 months looks positive, the next 3 months printed a -1% in expectations so a flat market is the current feeling as we go into the summer (and, broken record on once again, just you wait until they announce that election!). 


+33% see stronger sales activity over the next 12 months – plenty strong enough, but down from +46% for March, so somewhat less bullish. Average stock levels are now at a 3-year high, 43 properties per branch (back to pre-pandemic normal, arguably). +12% reported increasing tenant demand, so still moving forward, but the lowest print since April 2020 (!). -13% was the landlord instruction print – still moving downwards, but more slowly – and so +33% see rents rising still (so – just a reminder – this would be 66.6% of respondents saying rents are moving upwards, and 33.3% of respondents saying they are not moving upwards). Or – rents are now static or falling in 1 in 3 areas, could be a fair reframing of that stat.


Onto the growth report from the ONS. It was a surprise even to those of us (well, me) who predicted 0.4-0.5% growth for Q1 2024 – the likes of the National Institute of Economic and Social Research were predicting +0.2% back in January when I first put that prediction out there on the back of some very positive looking PMIs and lower gilt yields. Even I was too bearish as the print was actually +0.6% for the quarter. As usual, though, the growth report deserves a deeper dive…..


March saw GDP up 0.4% on the month (so, Easter being early and February being rained off clearly had a better impact than Good Friday slipping into March this year). February was revised to 0.2%, and January stuck at 0.3%. How those monthly figures lead to a quarterly figure of only +0.6%, I just don’t know. It’s mathematically impossible. You can’t go +0.3 +0.2 +0.4 and end up at only +0.6, even with rounding errors. It grinds my gears BUT the “error” seems like if anything, quarterly growth will be revised upwards not downwards if anything. The ONS boffins are of course far more able mathematically than I, but it drives me mad that they don’t explain what looks like an impossible anomaly. Just me? OK then.


So the recession is over, whichever way you look at it – and no-one really seemed to notice. There is still chat over the cost of living crisis but the google trends graph is quite illuminating there – we are at about 1/6th of the number of searches around cost of living compared to mid/late 2022 when it was really biting. The searches really died off around Feb this year, although I’d laid it to rest a fair few months before that!


Services were up 0.5% for March – really hot, on the back of the PMIs that have got even hotter since then – annualised UK growth based on Q1 is 2.5%, compared to 1.6% for the USA (first time we’ve been “ahead” for a long time), and up 0.7% for the quarter apparently – production output was up 0.8%, but construction output was down 0.9% for the quarter (PMIs were under 50 until very recently). 


There’s a story in here somewhere though. When you look on a year-on-year basis, the increase is only 0.2%. Of course, we did have those two consecutive quarters of pedalling backwards, so at least we are still up since then. Still – a lost year in the books, whichever way you look at it. 


But what of construction looking back at Q1? New work was down 1.8%, maintenance rose by a mere 0.3%. Private commercial new work was down 5.3% – but looks to have picked up according to the PMIs, so perhaps there was some seasonal blip. Infrastructure new work was down 3.6% which is significant of course.


Whichever way you spin these figures, though, no-one had predicted an economy quite so buoyant coming into 2024. Sunak, Hunt, and the rest who believe that the person on the street is really feeling this, or even cares after the grudges they are harbouring against the Tories, will be feeling unexpectedly jubilant I am sure and I can hear the shouting in the commons already about the “best Q1 in the G7”. 


That only leaves, of course, our favourite yields……we had a drive in the morning on Friday at closing the week under the dreaded 4%, but closed instead at 4.044% on the 5 year gilt. Given that we opened the week at 4.107%, we will take it. It was an incredibly boring week, really, apart from Friday’s efforts to get down to 3.95% – which were rebuffed, suggesting that equilibrium really does look above or at 4% at the moment. 


I have my own thoughts on why that happened (big bets on the back of the Bank of England language in general) and will go into those when I get into the Bank of England MPC report. 

The swaps – the gilt had closed Thursday at 4.008%, and so the swap (continuing the discount observed over the past several weeks) had closed at 3.92%. Lower than 12 months ago, and lower than one month ago (haven’t been able to say that much in the past couple of years) as it goes…..but only just. 


Treacle, still at the top end of my range, but going just about in the right direction, it seems.


So – filled with macro – once more into the breach, dear friends…..every 3 months the Bank publishes a full report on Monetary Policy (every other meeting). The report runs to a tidy 87 pages (don’t panic). Luckily – there’s a summary……we also need to get into what the important players at the Bank have said since the meeting, because their language is also critical (and they know that). 

Let’s just revise, for those who don’t remember the outcome of the last meeting with utter clarity, probably because they aren’t obsessed with all of this (I am, in case you hadn’t worked that out by now). Last time out we had a vote of 8 to hold the rate and 1 to cut. This was the first meeting where someone had not voted to RAISE rates since Q3 2021. That was a milestone.

The 1 “cutter” is a committed Dove, and has been focused on weakening consumption data. From everything I have seen (and discussed here in previous weeks) – she is right to be so, although I think there is an element of tunnel vision. She was never going to be a difficult one to persuade to cut. This week was 7-2 – as above – and that means someone else has “crossed the floor”. A big deal. Somehow the economy is holding up in the face of weaker consumption, and has grown in Q1 as we have seen evidence of now, at this point – so you can understand why the others are not so worried. But this 1 move is bigger than the initial move to cut from Dr Dhingra (the dove). 


Remember one more thing as well – this has to be a prediction about when you want this to kick in. This is easing that would start to take hold from around November this year. That’s the very tough part of the job. There’s one MORE big point that might well be impacting people like Dave Ramsden (who is the second “cutter”) – historically, in these sorts of cycles, the cutting has happened too slowly or too late. That might be playing on his mind, and I could understand that.


Anyway – we will get into the full “wargaming” at the end. That’s just to set the scene……


To clarify, the two cutters voted to cut by a mere 0.25%. A token nibble, it would be described as. The report was before the growth figures were released – and the first question that many would ask is “why cut, if the economy is doing fine?” We do need to remember, a cut will take 6+ months to have an effect. Back to the summary……


The “market implied path” using the forward rates is – to be clear – the expectation that the Bank will cut the base rate from 5.25% to 3.75% in the next 3 years. That’s moved up a whole half of a percent from the last report 3 months ago, when the expected end point was 3.25%. That’s fairly big news.

The next part of the summary suggests that underlying inflationary pressures have continued to moderate somewhat in the USA. This isn’t really true, (well, its just wrong) and it bothers me that they would even say it. Inflation has just gone sideways and a touch upwards in the USA since the start of 2024. 


The Bank was still predicting +0.4% in Q1 growth (the report was released one day before the growth figures were out), and they forecast +0.2% in Q2. Given we are very nearly halfway through Q2 already, and the PMIs have been roaring, it will take something to go quite badly in the second half of this quarter to only increase by +0.2%. Perhaps Easter is a net positive in general (I’m not aware of this phenomenon, but haven’t studied it in detail) so missing it in Q2 where it normally sits will cause a base effect downwards – I’m not sure. But right now I’d stick a pin in +0.5% to +0.6% for Q2, personally. 


The Bank still sees demand growth as weakening. The pragmatist in me says that’s not happening quite yet, and April’s pay rises will contribute yet further. The problem that I’ve already told you the decision makers will be facing will be a low-looking inflation figure (thanks to energy prices dropping) and wages roaring according to April’s figures when they are out. There’s 2 sets of inflation data, one more growth print, and two more sets of jobs figures before the next Bank of England meeting.


The Bank does highlight, high up in the summary, that services inflation is still sitting at 6% and wage inflation is also still sitting at 6%. The Bank is now forecasting inflation at 2.5% in the second half of 2024 – personally, I can’t see how it doesn’t go higher but I’m certainly in a minority there (but I’m comfortable there – some would say I belong there). 


One of the most important points is that in 2 years’ time the Bank sees CPI at 1.9% and in 3 years’ time the Bank now sees CPI inflation at 1.6% i.e. below target. That leaves room, you’d think, for a cut. The last report had these numbers at 2.3% and 1.9% (which didn’t leave room for a cut). I’d love to know whether it is THIS fact that has influenced Dave Ramsden.


Let’s pause there for consideration. I sometimes flippantly refer to the whole “target” piece as a bit of a glorified scam. You get 3 years to get to a target and can get away with a lot in the interim, basically. I was jumping up and down in 2021 about all this because I said there’s no way we would be at target in 3 years time (and indeed, it has come to pass that I’ve been right about that, although April’s print which is out in 10 days time may still hit target, even though I think it will be a shade higher). These sort of inflationary cycles take 3-5 years to play out, the central bank always does the same thing – we are not a lot smarter than we were in any of those cycles, but we do have better, more qualified people in charge of the levers than we did historically. 


That’s not the only point though, or it would be easy to get lost in that point, perhaps I should say. We also need to consider what the job of a central banker is. They are not supposed to be making knee-jerk or “in the now” decisions, much as borrowers want them to when they are suffering from paying higher interest rates. They need to make decisions that are robust over decent time periods, and their changes don’t take effect straight away unless they are stark (dropping the interest rate to a 300+ year-low, for example, in the face of a crisis). They DO affect bond markets in real time, but the wider economy, not so much – because the wider economy isn’t affected by those bond markets in a particularly fast fashion. 


Therefore, the 3-year forecast period makes a lot of sense, you could say. It is definitely defensible. The problem that I have left, of course, is that the forecasting record of the Bank is completely woeful. That’s been picked up in the Bernanke report which I’ve referred to a number of times, and there are the small changes you can already see in this quarter’s report that I’ve been analysing here. Are the models suddenly brilliant overnight? Of course not. There will be months of tweaking, testing, reviewing, and then the politics of changing something that’s been obviously wrong for some time without leaving people with egg on their faces, naturally. 


So do I believe that, as we sit today, if we cut rates to 3.75% over a 3-year period, that inflation would be 1.6%? It’s possible. If the economy is particularly limp, it’s definitely possible. Is it the most likely scenario? No, I don’t think it is. There’s this amount of “extra” inflation that I’d think – from the research that I’ve done – sits somewhere between half and 1 per cent – that we will be dealing with at least for the 2020s, if not beyond. You would need an econometric model beyond my capabilities to get any closer than that. We have not only the services inflation and wage numbers (6% remember – treble the target) – which are moving downwards, but tend to move downwards at a very slow pace – a roaring services sector right now, in better shape than it has been for some time, with natural inflation – and still a lot of people living off cheaper debt than before (that dropoff is the counter-factual if you like).


How does this affect everything, month to month? Well, 100k people or so drop off a fixed rate mortgage that was around 2-3%, and have to take a mortgage at an average of 4.7% at the moment, we are told. That – near as dammit – doubles the interest payment, although doesn’t double the MORTGAGE payment, because the capital amount remains the same. There are “scrambles” that can be performed also – capital repayment holidays, extension of terms – all of those tricks have been made available and used. The mortgage payment moves up by around about 50% with very crude maths, without any of the other tactics being used.


On the flip side, we are now 2.5 years into this hiking cycle. At least 2 pay rises have been obtained, at an average that approaches 15% (pre-tax). That will equate to about 13% post-tax (because some income always comes before tax thanks to the personal allowance, of course). Inflation in that time period also isn’t far off – so there’s less money for consumption. That’s a fact, and we are seeing it year on year. There’s also that returned incentive to save which is chopping right into UK consumption right now – and I do struggle to see how it is holding up so well, but what I suspect at a very broad brush approach is that the wage increases are concentrated at the low-pay end, and that group tends to consume 100% of all pay rises – whereas the better-paid are increasing savings and keeping belts tighter, perhaps because of concerns of wars in Europe and on the borders, perhaps because of economic and election concerns – we will see as the year plays out. 


People stop dropping off the generous debt in 2.5 years time – or, from a mortgaged household perspective (remember, only 28% of households anyway); but that’s only if they were on 5-year fixes. We know from previous charts that 25% or so were using 2-year finance, and a smaller group (10% or so) were using longer than 5-year terms. Some were using variable so have been “riding the lightning” throughout. But, the point is that we have 2.5 years left for the last cheap 5-year deals to expire, so that drag effect will continue on a whole number of households for 2.5 years yet (if we all accept that we aren’t seeing rates sub-3% on household mortgages within 2.5 years time, which looks likely although there are never any guarantees). 


Either way – I find myself in a position now where I’m arguing that inflation without energy prices dropping looks more like a 3% number than a 2% number, and those factors like wage inflation dropping at perhaps an arbitrary 0.1% per month until they settle around the 2.5% mark. That’s 35 months or basically 3 years. A shock event could, of course, change that but this labour market looks inherently tight. 3% is by no means a disaster and likely helps the government (and as property investors, we shouldn’t be unhappy about it either). Rather than obsessing over decimal places, that’s an acceptable level of inflation and the Bank of England, in my view, would rather stay above or at the target than below it – because below is not where anyone wants to be, at this time. The government would definitely agree with that sentiment, to inflate away the debt and keep the tax take pumping upwards thanks to the evil frozen thresholds.


The long tails can subside at their leisure, and the Bank is in a position (thanks to their model) to now be able to vote to cut – if at the August meeting, the next report was going to suggest that without a cut, inflation would be say 1.3 or 1.4%, I think there would be questions as to why the cut hasn’t come about. Now – that level of reporting tends to only come out at the quarterly meetings accompanied by the full report – although I can’t believe that the updated models are not presented at each meeting, but they are not reported on apart from in the quarterly reports.


This – bearing in mind I don’t have perfect visibility or information – does leave the floor wide open for a cut in June, although I still think August is more likely. If we were well above 2% for April’s inflation, even in the very favourable circumstances we are seeing for CPI with energy prices dropping thanks to the cap – that would be a surprise, but I think the mortgage “drag” will keep on keeping household consumption down enough to suppress the figures. 


Spending is still down 8% compared to last year on debit and credit cards (ONS) – concentrated mostly in the 55+ demographic who are spending 16% less than they were at the beginning of 2020 (although the source of that is Revolut and I am not sure that over-55s using Revolut is representative of all over-55s), but it does make sense from a cultural perspective to suggest that they are the generation who will most see the benefit from savings rates up at the 5% mark or so.


The question I ask myself is “who can cross the floor” – as in, which members of the committee could change their mind. I think we are now in a place where the two cutters will stay as cutters, and there are 2 who definitely won’t be voting cut next time out, and one who probably won’t be. But, there is a possibility – right now – of everything from 6-3 in favour of a cut to 6-3 in favour of holding (or even 7-2 again, I suppose). The most “live” meeting for some time.

The result will depend on the data, largely, between now and then. It will also depend on whether we miss consensuses to the upside, rather than the downside. You’d expect April’s growth figures (released in June) to be pretty good, given where PMIs were in April, although I still don’t know about that Easter effect. Anything lower than 0.1% growth would be a surprise though, I’d think. May looks very positive thus far, so you’d have to have that pegged in at about 0.2-0.3% again. It’s difficult. In fact, I’d say that the next meeting, as we sit today, is about the toughest meeting to predict certainly since September 2023 when they opted to end the current hiking cycle, if not even tougher than that one.


Then consider human behaviour. It would only take one person to remind the committee that they started hiking too late – a fact that is now universally accepted – and point out that they don’t want to start cutting too late. Dave Ramsden might be that one person.  


Language is everything though. The report’s penultimate paragraph is fairly clear:

Monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term in line with the MPC’s remit. The Committee has judged since last autumn that monetary policy needs to be restrictive for an extended period of time until the risk of inflation becoming embedded above the 2% target dissipates. 


That doesn’t SOUND like a cut in 6 weeks’ time to me. The changes in 3 months to the Bank forecasts are pretty massive to be honest – and that’s why I used it as this week’s image. The big one is that Bank rate from 3.7% in Q2 2025 is now expected to still be 4.5%, which looks a lot more realistic to me. The expected pace, according to the market curve at the moment, is one cut every 6 months – which would be painfully slow, and very orderly, and represent the “soft landing” scenario – which now does look the most likely in and of itself, but still only about 40% likely. All bets are off in the event of exogenous shocks, and the current advance of Russia throughout Ukraine – now getting precisely zero coverage since the West preoccupies itself 100% with the Gaza situation instead – could easily cause the next exogenous shock. 


Growth forecasts are nicely upgraded now, but the Bank’s forecasts for growth still look too low for me. Why are they predicting 0.2% GDP growth for Q2 when the real time data looks so good – I don’t know – and we are 40% of the way THROUGH Q2, so it’s hardly difficult. Looks a bit ridiculous compared to the NIESR forecast of 0.6%, which is very much in line with what I’ve already said about April and May thus far. They – like me – are basing this on very positive PMI readings for services, and that’s using their base case for June being about 0.2% growth. Getting anywhere near 2.5% per year is a great result though, at the moment.


The problem with this is, if NIESR, and I, are right about Q2 then that really takes away from the case to cut interest rates – if anything, remember that sentence from the S&P Global report just a few weeks ago (which has now disappeared from their website) – these economic conditions look more like one where rates need to go up rather than go down.


Positive economic news like this will see limited calls for interest rate cuts……people will feel it in their pockets for mortgages but an economy growing at 2.5% will start to lift all boats, finally – even if we are only getting back to where we were in 2018-19, the voting public won’t forgive the idiocy that has mostly presided over the UK since then, even if truly speaking the pandemic is 80% to blame. 


Off the fence then – as at today, I see no cut in June, and a chance of a cut in August, but I need to be convinced as yet that the brakes are coming on this patch of economic growth. They will do – at some point – and I’ll be glued to the data so that I can call it as I see it, right here in the Supplement. The 4.5% base rate a year from now looks quite realistic to me at the moment, and with these economic conditions, I’d say 4.5-4.75% in 12 months’ time looks quite realistic. Let’s hope I’m wrong on the bearish side, and it doesn’t still start with a 5, is all I will say!


Well done as always for getting to the end – remember the Super Early Bird tickets for the next Property Business Workshop on Thursday 4th July – 

There’s only one way to deal with all of this continual noise, of course – Keep Calm, ALWAYS read or listen to the Supplement, and Carry On!