Supplement 120223 – Bank of England debrief

Feb 11, 2023

“My only surprise is that you are surprised.” – Adam Lawrence, econopreneur and all-round difficult individual.


Welcome to the supplement and yes, I did just quote myself AGAIN! I have reached a higher high, or plumbed a deeper depth, depending on your thoughts. (I enjoyed the feedback so much last week I thought I’d go again – I also thought I’d seen this phrase used before but it appears not!)


One last minute entry – I note that Russia has cut their oil production by 500k barrels per day from March (they deliver about 10m barrels or so, so that’s a 5% “experiment” for those of us who think Putin is testing the water). OPEC+ are unlikely to pick up the slack, as they will not want to work actively against Russia – and all boats generally benefit from events that raise the price of crude, of course. This is 0.5% of the world’s daily oil production (ish) and raised prices by 2.6%, very sharply, in a move that stabilised. Or – it had an order of magnitude 5 times as effective as the cut, BUT half of the magnitude of Russia’s slice of that production, which is very important. They have stated they won’t supply oil to anyone who is entertaining the price cap – this is tracking very closely what they did with Nordstream, where they messed around quite a bit before stopping supply altogether; so the notion that they cut half their oil production and increase the price by a staggering amount is not out of the realms of all probability. However, some of that 2.6% will be traders buying speculative long positions in case he does exactly this. As so often in this conflict, the eyes turn back to Putin for his next move. This is just one of the upside risks that I’ve been talking about for the past year or so, which will have inflation consequences. It’s no coincidence that this happens just as China’s reopening is underway – just as the gas squeeze happened on August 31st as we lurched towards winter. Keep an eye on this as we go through the year.


I had a message from a contact last week who trades a large volume of UK property. He simply said, after the Bank meeting on Thursday 2nd Feb: “What a day to be a property trader.” On further investigation, it seemed that the phone had been ringing off the hook as a whole number of landlords remaining on base rate trackers were holding out hope that the pain was over and it wouldn’t be another hike, let alone another 0.5%. Most can work out that the final hike in this hiking cycle is unlikely to be more than 0.25%, even if their fingers are nowhere near the pulse – so the indication is that there is at least another 0.25% to go. The straw appeared to have finally broken the camel’s back.


Of course, these landlords know not how very fortunate they have been since March 2009 and the drop to 0.5% base rate. Yes – section 24 royally screwed them over (technical term!). However, 13 years before passing this base rate was a pretty sweet deal, let’s face it. I cast my mind back to a property meeting I attended in January 2017, the headline speaker being a guru (and, this time, an actual one who is worth listening to). There was a straw poll afterwards – what’s the biggest risk to property investors? (The question probably omitted the words “this year”, that was the likely intention). I put my hand up, like an enthusiastic schoolboy on the front row of a classroom (in reality, I was lounging at the back, dressed like a scruffbag) – and, when chosen, offered up “interest rates”. A worthwhile exchange followed where I discussed how I was addressing 10 risks that the aforementioned guru came up with on the spot, and although we agreed to disagree, my primary point is that you cannot control interest rates, and therefore they will always remain the biggest risk. I’m sure at least half the room thought I was mad – but then again, perhaps I am.


That same room asked whether people thought it was a good idea to buy property that year, and whether prices would go up. Again, I was the strongest hand up the very most quickly – Brexit, the election of Trump, and a variety of other objections seemed to be resonating around the room. It was an experienced room, in a high value area in the East of England. Not my usual fare in terms of investment areas, so I could see the point of some of the gloom in the room. The area proceeded to only move up 5.7% total in the next 3 years, but is up 31.5% since Jan 2017 as at the last ONS figures available (November 2022). The price of inaction right there.


So I found myself last week looking at that message from my contact and processing it – and the only surprise that I had was that I was surprised. One behaviour I read about that was framed very well here is best put thus: “People are great at adapting but terrible at anticipating.” This is self-evidently true in many situations including the impending economic gloom – had people started behaving as though we were already in a recession when the warning signs started in late 2021, inflation wouldn’t have gone where it has been, and the following reaction including wage/price spirals wouldn’t be well underway. But – people will only cut when things are cut for them, as a whole (individuals of course are more than capable of being very well prepared – exactly the sort of person who reads and enjoys the supplement every week, as it goes!).


This, then, shouldn’t be a surprise as the market continues to inch downwards according to the “real-time” index of the Nationwide building society (Halifax saw a flat month instead). January is the 5th down month in a row, according to Nationwide’s figures. The ONS instead is still back in November ‘22 and only sees a 0.3% drop with no seasonal adjustments – it’s first drop since September 2021 and the most recent stamp duty cliff, of course. The deals are coming – for those at the coal face, they are already here – for those who are depending on the open market to source their next property, this is likely to play out over the next few months. The base rate will continue to move upwards, whilst the bond yields and resulting fixed mortgage rates will go sideways or perhaps down a little (my jubilant efforts last week were tempered fairly quickly this week, as the bonds and swaps bounced back to where they were before last week’s Bank meeting). The spread between the 5y gilt and the swap rate has definitely narrowed though, indicating lower volatility, despite these movements.


The resistance will remain to the downside until inflation is conquered, and if you’ve been following for a while, you will know where I am on that one. Inflation WILL be resistant, mostly due to the incredible labour market. The social problems are, sadly, not solved by this labour market any more because the cost of living makes it difficult even for those who are in full-time employment. The risks still remain to the upside – the unseen, the energy markets (we already know prices go up on April 1st, and October 1st will no doubt see a tempered price cap again to £3,500 or similar), the price of oil could still take a nasty turn to the upside, and the entrenched industrial disputes will empower companies to raise prices when the higher demands are eventually negotiated and dealt with.


Primarily though this week I wanted to provide a summary of the Bank’s most recent Monetary Policy Report and my thoughts, as there’s been a week for things to sink in and for the full minutes to be published.


In terms of the components of inflation – petrol and energy make up around 3.5% of the current figure, with services around 3% and goods around 4%. All three individual major components in themselves are above the 2% target. There are base effects to now kick in since prices went up so far last year from April 1st in terms of energy – however, a lot won’t drop off then because the price cap will once again be up and the petrol price will be at the mercy of the crude price, of course. 


The Bank now see inflation at around 4% at the end of this year, which is the lower end I could see, being honest. I believe we will be closer to 5% than 4%. Either way, this likely moves into the territory of “inflation that really benefits property investors” – so, in isolation, is good news for asset owners. The bond markets also believe that base rate will top out at 4.5% in a few months’ time, with a slow decline back towards around 3.25% in early 2026. This gives a much more realistic picture of just how stubborn inflation might be, and the rates needed to combat it – and bond yields are likely to track these numbers but be perhaps 0.5-0.75% below them as a general rule, once base reaches its peak and there’s some stability in the loosening cycle (notwithstanding any surprises, and I should definitely say IF there’s some stability, not when!)


The Bank have also started to formally recognise the chance of persistence in the inflation – I see it as more of a racing certainty than a chance, personally – they framed it like this:

“Headline CPI inflation has begun to edge back and is likely to fall sharply over the rest of the year as a result of past movements in energy and other goods prices. However, the labour market remains tight and domestic price and wage pressures have been stronger than expected, suggesting risks of greater persistence in underlying inflation.”


The notoriously bearish Bank unemployment forecasts see unemployment at 5.3% in early 2026 – I still see that under 5%, personally, but that’s a long way out to have to make a prediction, in fairness. The Bank also believes there will be no further price protection from October 2023 looking at the futures curves for energy markets – but it would be safe to assume that if the price cap was going to be at or above £4,000 let’s say, that the Government would intervene again.


Gas price predictions are half what they were back in November, but that’s because Europe as a whole has had a relatively mild winter from a temperature perspective, and also has weaned itself off Russian gas much more efficiently than expected, and has managed to genuinely cut usage (how much of that is affordability-led, it is hard to measure).


The big problems since before the pandemic are still with us, and are, in fact, worse today. Lack of business investment – expected to continue. Lack of productivity growth (as measured – ratio of output to input). Lack of overall GDP growth – 1% in the medium term sounds like the best we can hope for, at the moment – trending towards a Japan situation.


The Bank’s direct view on the current housing market is framed by them thus:


“Timely indicators suggest that house prices are likely to have fallen over recent months, after several years of strength. Alongside falling prices, indicators of housing activity such as mortgage approvals have declined sharply. Weakness in the economic outlook, combined with the impact of higher mortgage rates, is also expected to weigh on housing investment. It falls by over 6% this year, having risen by 8½% in 2022. Housing investment is expected to weaken further in 2024, falling by 8½%, before stabilising in 2025”


This is interesting. I would have hoped to see a little more nuance around the reason for mortgage approvals. The spike in affordability (which does seem well and truly over) – from 6%+ rates for 5-year household fixed rate mortgages back to 4%/low 4s as at today, only lasted 3 months or so – and in a time of the year where activity is always lower, of course. This COULD be more of a “kink” in the price curve rather than a simply downward trend-line, and that’s much more in line with what I think will happen – 2-3 more months of “real time” falls or flat market as indicated by Nationwide/Halifax, and then a pick UP in activity as these new world and 4-4.5% available rates see the homebuyer market recover from the doldrums of Q4 2022. In other words – thanks Liz (although something to take the froth off that market might not end up being a bad thing, in the long run).


We cannot ignore the massive falls predicted in housing investment though, of course. Again, these models may not be being tempered by the fact that construction materials have calmed down significantly (and may well deflate as 2023 plays out) – and also that labour, having spiked up in price, might need to come back a bit as well in order to win work. Those sorts of drops predicted in housing investment are obviously very significant – although they are not far off the drops predicted in business investment. We do also need to be cautious – this is somewhat also about “stimulus weaning”, because coffers have been generously filled by the state as part of the pandemic – that money seems to have worked its way through the system completely now, but the Government may choose to intervene here to encourage some investment or face certain defeat at the next election (the data says: Truss was 15 points behind in the polls when she was elected Leader – her honeymoon period closed that gap to 8 points, then her clear ineptitude created a 37 point gulf – this had improved to 19% but has bounced back a little again at the end of January as Sunak’s sound bites seem to fail to bite). 


Lower investment ultimately means lower stock – depending on how the immigration numbers pan out (which will to an extent depend on geopolitics and also natural disasters and other events far outside of our prediction capabilities or our control), this lack of supply might trump the lack of demand and shore up prices at some point, would be my view. We will see how it pans out.


Overall, the report is often using data that is 2 months old, or so – so you would expect with a view to being able to meaningfully forecast in real time, which I try to do, to be somewhat ahead of some of this – however, remember that monetary policy tends to take 6-24+ months to kick in – so we won’t see much of the real “brake” on the economy panning out until summer this year when the 3%+ interest rates have been in force for enough time.


Wage growth for the moment is projected to continue around 7%, which will, of course, once inflation is below this figure, empower spending and improve consumption – although overall predictions for household consumption are for it to fall this year as the squeeze bites, energy bills go up again and mortgages overall become more expensive.


I want to close by just sharing the results from 20 other forecasters that the Bank look at, and also to share my thoughts on those, versus the Bank’s:


“On average, respondents expected GDP to rise by 0.1% in the four quarters to 2024 Q1 (left panel, Chart A). Responses ranged from -1.5% to 1.9%. Four-quarter GDP growth was then expected to rise, on average, to 1.6% in 2025 Q1 and 1.9% in 2026 Q1. These forecasts are all higher than the MPC’s modal projection.

External forecasters expected an unemployment rate of 4.6% in 2024 Q1, a little higher than the MPC’s projection (middle panel, Chart A). The average external forecast falls to 4.5% in 2025 Q1 and 4.3% in 2026 Q1. By comparison, in the MPC’s projection, the unemployment rate rises to 5.0% in 2025 Q1 and further to 5.3% in 2026 Q1.

CPI inflation was expected to fall, on average, to 3.9% in 2024 Q1, a slower decline than in the MPC’s projection (right panel, Chart A). Responses at that horizon ranged from 2.5% to 5.1%. The average forecast was 2.2% for 2025 Q1 and in line with the target at 2% by 2026 Q1, both well above the MPC’s projection.”


My feelings here are that GDP could easily be flat this year so I’m largely on board with that – could be a recession, but either way it is really in the lap of the gods as we’ve avoiding a definitional one with a better-than-expected Q4 2022 (remember, two quarters of negative growth in a row). The average forecaster is less gloomy than the Bank on GDP, you’ll notice – I’m inclined to agree with a drag effect – i’d be around the bottom 25% of the predictions, in the 1-1.5% range beyond this year.


Unemployment – as discussed I’m sub-5%, and see mid 4’s as where we get to, notwithstanding a shock. Inflation-wise, no surprise, I’m right at the top of the range. 5% for the end of this year, 3.25% for the end of 2024, going beyond that is a bit of a fools errand. In short – prices to be sticky and external factors, plus the energy crisis as it plays out (please don’t think that the end of the Ukraine/Russia conflict, whilst it can’t come soon enough, resolves the energy crisis – it absolutely doesn’t and we have structural problems which are 20+ years in the making that are finally going to play out on a global basis unless there’s a very fast breakthrough and implementation in technology, in my view), plus the tight global labour market, will keep us on our toes from an inflationary perspective, in the medium term – before the longer term deflationary forces kick back in.


Our image is a teaser for NEXT week – regarding some thoughts around the borrowing cycle for those that use rolling 5-year fixed debt – some lessons to be taken away from this market and also some theories too. I hope that’s an enjoyable and helpful macro overview and answers any questions you might have, particularly on current investment and also where some of the rates might go over the next year or so! Until next time…..keep calm……and carry on!