Supplement 240923 – cause célèbre ou raison de célébrer?

Sep 24, 2023

Energy efficiency. This is critical to making our homes cheaper to heat. That’s why we’ve got big government grants like the Great British Insulation Scheme. But under current plans, some property owners would’ve been forced to make expensive upgrades in just two years’ time. For a semi-detached house in Salisbury, you could be looking at a bill of £8,000. And even if you’re only renting, you’ll more than likely see some of that passed on in higher rents. That’s just wrong. So those plans will be scrapped, and while we will continue to subsidise energy efficiency – we’ll never force any household to do it.”

 – Rishi Sunak, UK Prime Minister


Welcome to the Supplement everyone. This week I went French, briefly – a cause célèbre is a controversial topic, whereas a raison de célébrer is a reason to celebrate. Of course – these two things and this week’s quote are not mutually exclusive – although I feel that those popping the champagne corks this morning might want to reflect on a few critical matters, which I will lay out this week. Before we get stuck into Rishi (or, in reality, more find the middle ground between the political ideologies of left and right, who are both useless in the Net Zero discussion), however, the macro roundup of an eventful week:


I’ll start with the most important piece of the jigsaw – core inflation. This faded back into the background this week because the consensus was that higher oil prices (since Saudi Arabia and Russia collaborated 3 months ago to withdraw 1 million barrels of supply per day, about 1% of the world’s demand) would force CPI back up, but of course core does not include energy prices in order for it to be a much less volatile and more realistic measure of what is going on. Core was predicted to fall (from 6.9% to 6.8%) but instead printed 6.2%, which is a big miss to the downside. Super news? Well, it needs to come down so on balance it is a net positive, although a little later I will get into what it really means. The last 3 months on core, annualised, would see core at only 2.4% – this is too hopeful, as inflation tends to calm a little in summer months – but no-one can argue that this is the wrong direction of travel.


That’s the biggest downside miss for years, and it had a predictable effect on the swaps market. The “stronger for longer” (the argument that rates will stay at this level for years, which has been coming down dramatically since early August as discussed in the past couple of weeks) has definitely been weakened by this event. It is now bordering on a trend, and that’s given the markets and the international lenders more confidence.


However, we need to learn some lessons here from the US. Their economic data looks much more positive, even though their composite PMI number (the rate at which manufacturing plus services is expanding or contracting, 50 is staying the same) dipped to just 50.2 earlier this month. We are under 50 in the UK – BUT the US spent 9 months sub-50 before not having a recession and instead having a resurgence. This has all led to higher bond yields in the US, and for the first time in what feels like a lifetime the US 10-year bond yield is above the UK bond yield after the Federal reserve committee met earlier this week and the “dot plot” (a very low-tech “best guess” by the committee members as to where rates will be in the next couple of years and beyond) caused a stir as it suggests “stronger for longer” is very much the path in the US. This trend might be more of a blip whilst the economy remains robust, with the doom-mongers scratching their heads – that’s perfectly possible here.


If that hasn’t made your head hurt – well done. The moral of the story is, this is a feature-length film not a battle won in one or two months. That’s an inflation (and hiking) cycle for you. It should be remembered that there are no similar cycles – in history – that have ever led to a soft landing so you are asking a government to do what hasn’t been done before, with world class support from their central bank. Frankly, the Federal Reserve has made the Bank of England look like idiots in the past 2 years or so. You do also have to throw into the mixer that US inflation bubbling at a little under 4% is secretly an absolutely fantastic result for the US government looking to inflate debt away, so they are at a stage where they CAN take a chance by lowering rates if they wanted to – whereas the UK is just not there yet. If you could ask Rishi, or Jeremy Hunt – AND get an honest answer – I am sure they’d agree around 4-4.5%, although it is a risky game.


CPI – the headline rate – missed its prediction to the downside by a little less than core, but still it was overestimated. The 6.7% (versus the 7% forecast) grabbed all the headlines – although this means that the economy is slowing faster than expected, which is in line with the recent trends around unemployment (up 0.5% last quarter) – the US range is tighter and also has been up and down, so they are still running at 3.8% from their low of 3.4%. Unemployment – like inflation – can be like a horse bolting out of the gate if the people in power aren’t careful. Things should pick up close to Xmas as they usually do with temporary unemployment, and if they don’t then that in itself will be a problematic signal. I’ve seen very little commentary on the jobless rate, and whilst everything up to around 4.5 or 5% could be seen as “positive” unemployment, i.e. it will drive productivity upwards which has been a continuous struggle, it is very easy to go from the positive argument to a negative one.


That leaves us with the big one – the one everyone was waiting for. The one that I suggested last week was the most important one yet. The Bank of England Monetary Policy meeting. You won’t have been under a rock since Thursday lunchtime and thus you will already know that the Bank voted with their slimmest majority for some time – 5 votes to 4 – to hold the base rate of interest at 5.25%.


The closeness of the vote seems entirely justified. As I said last week, the most important one since the last one, and the macro data from this week all posted in one direction – an economy teetering on the edge. The governor and deputy governor both voted to hold, departing from the hawks for the first time in a fair while. It’s tempting to say that because Bailey voted to hold, it is likely the wrong decision – but that would be too harsh.


On the face of it, there was only one reason to increase – the continued increase in wage rates, or at least the persistence of them. At this stage, the most likely fuel to the inflationary fire is putting more money in people’s pockets – and the response from companies unwilling to cut margins is either to put prices up or cut jobs. They are doing both, at this time, as the figures show. It is a bit more complex than that though – the only advantage to the Bank of England’s relative inaction or lack of pace in this hiking cycle is surely to look abroad at the bigger economies and central banks that have moved a little more quickly.

Neither the USA nor the Eurozone has their inflation under control. Both have been more proactive in hiking than the UK. Neither are yet talking about cuts in the rate. It’s definitely too early to call the 5.25% the top – a “hawkish pause”, a carbon copy of the Fed’s strategy earlier this week, is more accurate. As I’ve said consistently throughout the hiking cycle, the more important point is around duration than peak – and the Bank seemed to have tried the “stronger for longer” argument here too. Here’s the thing though – in the US that looks more believable because there is larger underlying economic strength in the engine. Right now, the UK economy looks weak – although we’ve seen this volatility enough during the recent years to know not to hang our hat on one month, or one quarter, as “the answer”. “The answer” is still the same – there isn’t a looming crisis on the horizon that is obvious, but there are a whole number of risks to the upside – Putin’s control over the global oil price being only one of them. A cold winter – related to that risk – being another, of which we truly have no control. 


Was it the right decision? Personally, I’d have voted up at this meeting. Through the entire cycle, we’ve been too weak in making the tough decisions and I think this is another example of that. Up more, more quickly, means down more quickly and duration is the key as I’ve said. To an extent a hiking cycle NEEDS to hike until there’s at least a fair amount of stress, if not a break – going over would be better than staying under, and less harmful in the long run. It is genuinely a close one, though. What did the markets say, though?

As always the bond market surprised me a little, and as always, this is why I’m not a bond trader. The 5-year gilt spiked a little (10-12 basis points) upon the announcement around lunch on Thursday – but at the close of play on Friday, the 5-year SONIA swap upon which the mortgage rates are based was just under 4.4%, and the 5-year gilt had sold right back off for its lowest close since early June at 4.11%. So – the market on reflection seems to have agreed with the governor’s assessment, and/or does see real weakness in the UK economy at this time – it is a diametrically opposite reaction to the reaction to the Fed meeting on Wednesday, and it is hard to find another reason why apart from the comparative strength of the US economy, or the comparative weakness of the UK economy, or both.


So, enough lamenting the rates and considering the consequences, for this week at least. The big industry news was around Rishi’s Net Zero speech, which will have surprised very few, I’m sure. Firstly it was a relatively open secret that this was coming, as the way politics is carried out these days these soft-ish leaks are fairly rife, for those who are interested. They don’t always come true – mostly because when they are leaked, if there is a terrible backlash, they get a chance to u-turn before the first turn is made public.


Anyway – the first thing that struck me, without taking a political position, is that the basic subject matter of the speech did sound like common sense. A supplement around 6 months back examined the real energy problem as it currently stands, reflecting on the idiocy of the orange powder mob that is “Just Stop Oil” – and just how much we can generate as a country by 2050 using renewable sources. Nuclear remains the answer to all of that – but, 6 months on and 18 months on from the Russian incursion into Ukraine – our energy strategy has made limited progress since the then-PMs speech (yep, 2 PMs ago, you know him) in April 2022. Wind is failing to meet targets and we are yet to see evidence of the final investment decision that we’ve been promised on one more new nuclear plant during this parliament. The alternatives – madly pressing ahead – and a dream of a return to energy independence which we haven’t had for the thick end of 100 years, are of course desirable but simply not realistic at the timescales that were mooted.


Green lobbies have of course gone mad. There is this very strange situation which I feel obligated to comment on, at this point. Let’s pick on the 2 mega-billionaires that exist in today’s world – Bezos and Musk. Bezos, and those who retail goods to people, perhaps is not that extraordinary at all – retailers have often and still do often occupy the top 10 richest in the world – think Zara’s founder, and Sam Walton (before his passing) of Wal-Mart. Amazon of course has a gigantic tech business running alongside, and AWS (Amazon Web Services) makes a truck-full of profits as well. 


Musk – he’s much more of an outlier, really. He’s a strange one, and perhaps twitter (or X, or whatever) will end up being a great acquisition and the paid subscription model will work. It will be interesting to see – because you’d think at that point Zuckerberg just puts the hammer down on threads, which already has so many registered users, as “free twitter”. He may end up a media baron as so many who have trodden before him have done. The paid model will surely see content creators to need further reward (I’d think) since that’s the tried and tested model.


Anyway – most understand or think that twitter is little more than a distraction. What’s Musk really been up to? Firstly, dominating early-adoption of tech ever since the PayPal days, or before. What else though – taking advantage of humongous, multi-decade government subsidies in electric vehicles, solar panels and space travel. 


He certainly didn’t invent this model. Branson has followed a similar path, and if you want to create companies that have serious strength, then making sure there is government support for those industries is very smart indeed. However, the very richest are the very most hated by the harder-left occupants who are also generally pressing for “Net Zero at all costs” – even though they are the ones most likely to benefit from spray-gun subsidies that are not delivering enough of an investment return for monies invested in them.


I think, aside from the equally-extreme far righters, most have accepted that change is paramount and the current situation is not sustainable. There seems to be more “real time” climate evidence of change as the years roll by. However, sacrifice growth – or jobs – or healthcare – or pensions, or pick your poison – in order to get to net zero at all costs – ah, well, no-one actually wants to do THAT. 


So we have a massive gap between ideology and fact. Sunak, for me, bridged some of that gap in his speech. The “route 1” reaction to the news, as a landlord, is of course relief. No need to sell up. Frustration for those who have already spent funds, in a time of slim margins, to futureproof properties – although I’d argue they’ve still been very sensible. The core problem – the age of the housing stock, and having the most “leaky” housing stock in Europe – is not addressed and simply gets worse every year. The sensible approach part is not putting extra pressure on a sector that is delivering zero margin to the average mortgaged landlord at the moment, when rents are already rocketing without another reason to put them up. It has saved many thousands of tenancies and homelessness projections can be revised, which is pleasing for everyone.


In fact, he tried to strike more of a political hint towards the upcoming election campaign, I think. “We will not MAKE you do stuff” would be a good summary of most of the speech. What’s the implication? That the other side WILL make you do stuff. Appealing to the freedomites/libertarians out there. Very few people want to be told what to do – although plenty of people want everyone ELSE to be told what to do, whilst they remain free to choose, of course. Likely some clever politicking, and keeps some who are more inclined to vote Conservative but are definitely in the swing camp, on board. 


Insulation schemes will continue and be boosted. The understanding is now clear that the Government will need to pick up the tab for energy improvements to buildings, whether they are let or not. Section 24, in a perverse way, has guaranteed this situation – taking taxes when there is little or no margin because of the interest rate environment. The figures have been made clear enough by the great work of people like Ben Beadle at the NRLA and the government has listened – and I suspect Labour might be similar, if their rhetoric is to be believed (is it ever?).


Heat pumps are much more of a bust than boilers, and typical of the “Net Zero at all costs” mentality – expensive, and unworkable for many properties. Not the best answer – just the answer that is there at this time. We need research and development money – and a LOT of it – to get better before rolling out tech that in 10 years time will be redundant or extremely expensive to run.


Electric vehicles will just need a lot more in terms of grants to make them affordable – not because it can’t be done, but because that’s what the big motor companies will lobby for! There is some truth to it as well, of course, and we are yet to hear of a great battery recycling solution as well.


Pragmatism is all fine, but the pushback will be that enough is not being done, and it isn’t fast enough – however, for a simple economist like myself, it comes back to having the business case for EVERYONE, rather than just a few billionaires, to make a brighter future with green solutions. Research and development is what will get us there, and then investment can be raised via green bonds or equivalent, with a manageable business case behind it.  


This throws a lot of the “penalise people for less efficient buildings” into the toilet – which was the suggestion for mortgage lenders, and insurers, in the consultation from the early part of this decade. Will there still be green rewards? They do make sense, particularly if subsidised – that will incentivize those companies accordingly. Put simply – if you want something done, pay someone a fair price for it. The issue usually at governmental level is establishing exactly what that fair price actually IS.


There’s a further problem which reared its head or accelerated during covid, which is simply never talked about but is actually manifesting itself into the headlines somewhat at the moment. Replacement rate of buildings. The UK has a unique problem in this department when you look worldwide – we industrialised first, and so our buildings are simply older. There are examples all over the place – prefab dwellings constructed for 20-30 years still standing and in use after 80. The most significant one at the moment – RAAC concrete in many buildings. What plan is there to replace these sorts of assets? There’s none. At a high level, someone noticed that in the post-war period right up to the 1970s, the problem was not failing to build new dwellings – we built at an incredible rate of 400,000 houses and above in some of those years. The problem was, we were overly zealous in knocking buildings down and thus the net dwelling addition to the stock was not where it needed to be. So – again at a high level – it seems we simply stopped knocking buildings down, mostly. Great plan – as long as we all pretend there is no such thing as an economic life of a building. Which, of course, there is. 


This all feeds back into “Europe’s most leaky buildings” and, of course, the relatively slow rate at which new stock which IS energy efficient is added into the stock (and 84% were A or B EPC in Q4 2021) is not diluting the problems with the old stock at a fast enough rate, since less than 1% of dwellings are added to the stock each year (and demand is above the replacement rate, so there is no room to get rid of the less energy efficient stock, without grant funding it – what we all knew all along, really, but Sunak has confirmed). This is why continuing and increasing insulation schemes does make sense. 


What has been solved is one more straw not to break the camel’s back – and, ideology or any self-interest aside, this has to be the right move and a good thing for the tenant – and the landlord won’t be moaning either, of course. Has it solved any problems? No. Is it the only correct and pragmatic solution at this time, in a world of various bodies foaming at the mouth and advocating “sorting climate change at all costs”? Yes it is.


I can’t leave this week alone without marking the one-year anniversary of the KamiKwasi “Growth Plan” speech. Remember – it was not an official budget – just a fine example of how not to govern, which led to Liz “the Lettuce” leaving office in a shorter time than her leadership campaign took. 


It might surprise you, but I think there’s some defence to be mounted here, because I’ve heard some unfair allegations this week which simply ignore the data – and of course, that is what makes me have to speak! The “moron premium” or similar was much bemoaned last year – the extra cost of international borrowing after this terrible plan was announced. However, if you look at the path of the rates, this premium was largely gone almost as quickly as Liz was. In early Feb this year, the 5 year gilt closed back below 3%, for example, and Liz was already well in the garbage disposal. 


What’s happened since then is a much more realistic assessment of the inflationary situation and the scale of how long rates need to stay higher to sort this problem out – none of which is in any way Truss-inspired. Indeed, her actions and those of her footsoldiers put an end to what was starting to look like a bubble in the housing market, pricking it before it could do any real damage. It slowed the market and inflation has done the rest – much better than a boom and bust. 


Don’t get me wrong – it was utterly clueless and inexcusable to attempt even a small tax cut because it was unfunded, and ignoring the independent body that was set up to ensure there is robustness and accountability for budgeting decisions (the OBR) was completely unforgivable, and incredibly arrogant. For that alone, the price needed to be paid – and anything other than a very quick de-throning would have been a disaster. Liz messed up – big time – and met the ultimate punishment. Consigned forever to talk about pork-related matters whenever anyone will listen – her latest efforts being around doing too much to the “pig on market day” or some similar nonsense. 


The very idea, which was the point of her putting her head above the parapet this week, that she could lead a Conservative opposition, is beyond hilarious. I am sure no reasonable Conservative MP will support that, although the lack of strength once Sunak has gone must concern anyone. Jeremy Hunt, I suppose (gulp). Back in your box, Liz, and the defence of her woeful decision making (the policy wasn’t the problem, it was the reaction to the policy that was the problem – really?) is best left in the history books.


Once more we are at the end for this week – I hope you enjoyed my take on an eventful one. Be sure to tune into the 9am live on YouTube if you can (or watch on repeat) – if you don’t already know about it, just search up “Propenomix” – please subscribe to the channel, and like and comment on the videos if you enjoy the weekly content (or even if you don’t, but if you don’t, how have you got this far!) – and Keep Calm and Carry On, of course.