Supplement 300723 – Energy Inefficiency

Jul 29, 2023

“It is the first responsibility of government in a democratic society to protect and safeguard the lives of its citizens. That is where the public interest lies. It is essential to the preservation of democracy, and it is the duty of the court to do all it can to respect and uphold that principle. But the court has another duty too. It is to protect and safeguard the rights of the individual. Among these rights is the individual’s right to liberty.” – Lord Hope of Craighead


Welcome to the Supplement everyone. We had a news week that was really befitting of the first week of the 6-week summer holidays for many schools in England – economic news was limited, although what little there was held almost uniformly negative connotations for the economy, which might be good news for those primarily concerned with the mortgage rates. Recession indicators strengthened by a considerable amount when looking at goods output and demand.


Even the Bank of England were relatively quiet, apart from announcing that they are engaging the ex-US chair of the federal reserve, Ben Bernanke, to lead a review into why they are quite so poor at forecasting. Results will be interesting, but as with all these sorts of pieces of work, are also 9 months away.


As per the new format I’m going ahead with the bullets up front, sticking to the new number format for the purpose of the NEW audio version which I’ve managed to get online.


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  1. The “flash” (real-time) manufacturing index hit a 38-month low in July meaning there is less demand for goods and also lower production plans for the near future
  2. The services PMI index is still above 50 which is therefore still positive, but only hit 51.5 against a consensus forecast of 53, down from 53.7 last month and therefore faster cooling than expected
  3. Both these pieces of news are great news for inflation control, which feeds into the interest rate in short order – but how short?
  4. The gilts generally tested a new recent low on Monday but have hardened another 20bp since then – the bears are still in control
  5. Does this mean the Bank of England, all things considered, should still raise the base rate of interest next week? There’s arguments for and against.
  6. Some surprising news on transaction data from HMRC for June – still above pre-pandemic levels in spite of a rocky month for lending, although a lag would be expected
  7. More mutters that the EPC target is no longer 2025, but “more breathing space” is being given – combined with a mooted “boiler ban” by 2035 in rentals being phased out
  8. The SNP have mooted a completely unworkable policy in a society that protects private property rights – what they are considering risks banning the sale of properties that don’t meet the EPC C standard by 2025 and the maths doesn’t add up
  9. The really simple conclusions around energy performance that won’t surprise anyone but still seem to somehow elude the government – access to the hardware, grants that work, the role of loans, and the scoring mechanisms and their usage
  10. A window into the next 6 months and beyond – yoyo times to continue


Standard and Poor’s (S&P) released their UK real-time figures for July this week, showing a 38-week low in the manufacturing sector. The cost of living is biting against demand for goods, and there is a faster than expected downturn both domestically and abroad for manufactured goods. From the manufacturing perspective, the performance is weighing on the entire economy in spite of the massive size of the services sector in the UK versus the manufacturing sector.


Interest rate rises would therefore be deemed to be “working”, if “working” means forcing us towards a recession. There’s limited choice though; as discussed many times, it doesn’t matter where the inflation came from – to choke it off and stop a wage-price spiral continuing, it needs to be choked off at the largest point to be as effective, as quickly as possible – consumption. 


The much larger service sector fell more quickly than was expected, and trends towards 50 (remember, the midpoint of the index is a flat forecast from the purchasing managers in the largest companies that are surveyed in this index). It kept its head above the 50-line at 51.5, but with manufacturing at 45, the composite index was 50.7, which would enable the economy to be described as close to stalling. 

The implication here is that inflation could fall faster than expected, if another disappointing number is hit next month here. It won’t end overnight but expect bad economic news for the summer, as discussed, meaning that inflation will fall and so will rate expectations. I’ve spoken for a long time about a sticky period to the downside, but that sticky period is really limited to between 2 and around 4.5 or 5 per cent – it isn’t an exact science but the road to 5 on CPI looks a lot smoother from here. 


We’ve also looked in more detail recently about services inflation and just how much of CPI they are a component of – a massive 47%. If this number is more under control as the services sector cools, then given that every other component of CPI has been falling already, this could really boost that drop down to below 5%. Good news for Rishi in his one pledge, even though all 5 was always a legal impossibility in my view – and the cruelty of the law was shown this week as the government’s response to the high court ruling around hotels and their suitability leads to them moving forward with plans to put 2000 migrants in tents as we face the best weather-led opportunities to cross to the UK for the next 3 months.  


At the risk of getting political – back to inflation. If the services index drops below 51, it looks inevitable that the balance on the PMI is negative, which you would expect to lead to recession in relatively short order if it stays there. There’s still volatility and unpredictability here, but a negative growth number for Q3 2023 looks like the most likely outcome at this stage. The Q2 number is hanging in the balance, and so that could be the technical recession – that’s by no means a certainty, but at these very shallow levels it really makes very little difference anyway apart from psychological. People are struggling. 


So – even the inflation bear that has been me for 2.5 years now, is seeing that the peak has very likely gone. The numbers above mean that core inflation really should fall for July as well, when the number is released in August. CPI in July as discussed before is on a guaranteed downward trajectory with food and energy prices falling. So – over to the Bank of England – the job is done, right?


Not necessarily. The Bank has its single purpose (in theory) in terms of there being one target – inflation. That is a singular failure, of course, at the moment, and has been since September 2021. However, there are other mooted or implied targets – such as unemployment, which at the surprise 4% is still very low, although where the natural rate really sits these days in the UK is harder to establish. It also has a significant role at this point, in my view, to manage the cost of debt to the UK. The argument over the UK gilt prices versus other, smaller, more indebted nations (in terms of debt to GDP, and in terms of how much of their GDP they spend servicing their debt in percentage terms) and the premium you can get at the moment for investing in the UK is not wholly explained by the currency differential, in my view. UK debt is too expensive, and other less attractive nations are too cheap. 


The Bank therefore needs to manage the expectations of what are hawkish international debt markets at the moment and keep those yields down, in order to reduce the debt burden on the government and the entire UK. I’d see this as a very important objective when we are at this range of debt coupons, with the amount of debt that we’ve picked up in the past 15-20 years. A rise should send yields down, or perhaps more accurately, the lack of a rise is likely to send yields up. Also – the two biggest central banks in the world, the federal reserve and the ECB have both put rates up again in this past week by 25 basis points. It’s unlikely that the Bank of England won’t follow suit, especially as the Federal Reserve is so much further on in the cycle than the BoE.


Why are the Fed still putting their rates up, then, when inflation is looking like it really is under control? Well, some of the US economic data is suggesting that the economy is still running a bit hot, even in this new world of higher rates. The ECB have tactily suggested they can now pause having hit 4.25% – but if you look very simply at the situation, the UK and the US were at effectively zero whereas the ECB started at -0.75%, so the differential is not so significant.


The Fed might have done their best piece of central banking thus far now they’ve hit 5.5%. I don’t believe for a minute they are really considering going up from here, but anything they say around raising rates is now more credible than it has been for 20 years. Their actions speak. The pause, and then hike, is a sign this isn’t over – and they could pause for 2 or 3 meetings before the market really believes they aren’t going to go up anymore. I’m just going to call them out now.


When will we be ready for this pause/hike strategy then? If not next week, September’s meeting? Yes, I think we might be, if the economic data plays out as predicted over the summer. Will we then still put rates up again at the November meeting? Quite possibly, that would definitely be a strategy worth copying from the US, and we will have seen the effectiveness of it by then, if I’m right. Still, the rise in November would be attacked by the press as we should really be feeling the pinch by then, particularly if we have a cold winter or are disrupted by some early snow.


Controlling the gilt yields looks a tough job, too, with an attempt to take the 5-year back below 4.25% this week thwarted considerably, as it closed the week nearer to 4.5% than to 4.25%. Swap-watch, my favourite pastime these days it seems, saw the 5-year swap close the week at 4.75%, which using my rule of thumb keeps 5-year cost of debt to 6.75% including arrangement fees, so say 5.75% pay rate with a 5% product fee. Ouch, but still 50bps better than a few weeks ago. Expect some new lows to be tested once rates do go up again, but it will also depend on the commentary AROUND that rate hike, which the Fed this time seem to have phrased well – will Bailey be able to do something similar?


It’s worth taking a segue into the HMRC transaction data for June, however, to also put things into some context. Technical recession hangs in the balance, but is that a real reason for doom and gloom? Would it be a “real” recession/would it be significant? Not yet, would be the answer from anyone sensible/non-sensationalist. How are things doing compared to pre-pandemic – as I’m sure you are bored of hearing about “base year effects” by now – there’s not a lot of merit in comparing ‘20 to ‘21, or ‘21 to ‘22 – ‘22 to ‘23 is better but still imperfect thanks to the covid nuances – ‘19 to ‘23 (with some allowance for the fact that is 4 years, although “lost years” are not uncommon and they sometimes become a decade or more, just ask Japan) is a better yardstick as yardsticks go.


2019 for those who remember it (and really, it was an unremarkable year – media chatter dominated by Brexit, soft, hard, oven-ready, hard-boiled, botched, whatever. A flat and trappy property market. A fairly whipsaw general election to end what was otherwise slow progress, late on in a comparative boom, although that boom was subdued by carrying the after-effects of the great financial crisis over the course of the 2010s, or so.


So, without seasonal adjustments, the data in June showed: a 9% year-on-year drop, with a 28% rise on transactions compared to last month. Commercial transaction volume was a lot tighter – 1% down YoY but 17% up MoM. The key part, however, is that these volumes are still above the pre-covid levels in a market which has tended down in terms of transaction numbers over the years. 


Two things to consider, really, to ensure we have the right context. Firstly, the sharp rise in mortgage rates in June will have kiboshed or at least delayed some transactions. Every time there’s a hint of a crash, the flakier buyers pull out, salivating at the potential bargains they will be able to wait for. In recent times, they’ve predicted 0 of the past 43 property crashes of course, and this is a negative expectation play – but it doesn’t stop people from making it.


However, the bigger disruption from the sharp rise in mortgage rates in June is likely to be felt further down the pipe. September and October figures are more likely to be affected by this, because it would be NEW mortgage offers (not completions in June, which would have been on the basis of mortgages offered since January) that would suffer the most in the price hikes. We will see how that plays out in a few months, of course, but should expect figures in those months to be somewhat suppressed (although, if rates keep trending down, the catch up would come from November and beyond). 


Mr Gove has also been active this week in discussing energy efficiency standards, and the Conservatives seem to feel they’ve hit a note with their supporters for rowing back on Green standards. Labour have opened the door, and the Tories might be falling into a trap here to show they MUST be, environmentally, the “least concerned” party. What they SHOULD do, of course, is invest in the right research, development and technology that can show a legitimate and acceptable return for the investment required – not score ideological points and play along with their caricatures. 


If you missed the highlights, they were a row back on the pledge to get rid of gas boilers by 2035 (this was first mooted to be “no new gas boilers in new builds” by 2016, if memory serves) – and a response to the English Housing survey released earlier this month (there hasn’t been capacity for a summary yet, but next week looks favourite) around delaying the 2025 target on the back of the findings. The EHS also looks at a world with a property of an average rating of D – although the government has finally voiced what the entire PRS already knew – an unnamed government official this week said that the EPC system needs “fundamental reform”.


To me, that sounds like code for “we can’t be sorting that before the next election” unless something is announced on the back of the English Housing Survey sooner rather than later. April 2025 is a pipedream. They also mention an average cost of £7,435 to bring a property up to C standard (that figure is now perhaps 18 months out of date) – much lower than some other quoted figures, but of course if half the stock is already at C or above (it isn’t, it is more like 40% – but half keeps the maths easy) then the average “below C” would take double that spend, as the number of houses to be improved would not be the denominator – the number of rental houses would be the denominator (unless I’ve understood the maths, of course!).


I think we really know that a huge grant scheme is going to be required, because the difference since this was first mooted is stark in terms of rental availability and landlords are proving that they aren’t just talking about it – they are selling, not at all costs but they are selling – more incentives to sell will punish renters significantly. A Labour government is much more likely to care about that than a Conservative one – just worth bearing that in mind, all clouds have silver linings…..etc. etc.


The Scottish government, having been behind on the energy efficiency front, are now keen to get to the forefront – despite having the worst demand/supply imbalance for rental property in the UK, at a regional level. Their plan – which has been absolutely lambasted by the right wing, the further right they are the harder they lambast – but, being objective, there certainly does seem to be some merit behind their argument. Being as balanced as possible, this is one more ill-thought out policy to lump on top of legislated rent controls, with what might well be a side effect of preventing the sale of houses with gas boilers (although if they do meet the C standard for EPCs, they would still be saleable). The Green zero carbon minister has mooted 2033 as the latest year to meet standards (which, as reality bites, means this is absolutely the earliest year they would be achieved) – and the stat of the day surely has to be the following:


The Scottish Government has confirmed the cost of converting all homes to the higher standards would be £33 billion. The current parliament will contain a support package of £1.8 billion, apparently. A shade under 5.5%, and we all know that £33 billion will go up, not down and is more likely closer to £50/£55 billion once the government is supporting, and that’s before inflation adjusted figures over the next decade……this is a pretty typical tale of the water going into the leaky bucket, at the moment.

How the EPC differential will be resolved is still anyone’s guess at the moment, but if any domestic energy assessors, commercial EPC assessors or insiders would like to comment or send me a message, I’d appreciate it! Scotland is starting to fix a broken system albeit underfunded – England knows that the system doesn’t work but in EIGHT years since MEES formed part of the law, very little progress has been made even on the scoring system, let alone how to fund the massive scale of the problem. Mostly – a fuss about nothing, that will be sorted out at the expense of the taxpayer once the scoring system is “fixed” – and I choose my words carefully there.


That leaves us with a short period of time to look into the near future and get us through to at least the end of the year. I’d expect we will end the year at a 5.5% base rate position, which was unthinkable 18 months ago – just because the economy was deemed too weak to handle it. The thing is – the economy may well BE too weak to handle it, but this is the path we are on. CPI will be under Rishi’s target which I think is 5.6% (or that’s what he will claim) as all the indicators are downwards, if we can avoid an energy price shock of some kind (Russia are not down and out, for example, and can still cause significant problems in terms of global oil supply, although they are problems they can ill-afford to cause). 


I’d expect mixed data from the housing market, with the recent mortgage price highs damaging the figures nearer the end of the year as discussed earlier in this piece. Still, once the crash has once again not come, there will be some latent demand to consider, and if stocks have a tough time which looks possible, there will be money hunting returns which as ever might have to end up in residential property. Commercial property will continue to have a tough time while yields stay high, and the range for the 5-year gilt looks likely to be above 4% and below 4.5% come the end of the year, although it might be possible to break 4% at the downside – although that would be unusual. It will depend on just how much of that technical recession or economic slowdown becomes a reality.


Inflation will of course have taken another few percent off the real price of property without anyone necessarily noticing. The national minimum wage moving up another 7% (or so) will be looming – it might even be more, depending on how much pace is lost in the rise in overall earnings over the coming months. We will have booked a “down year” in property prices, I’m sure, but probably one around the 5% mark in nominal terms, and actually will be set up for a nominal price rise in 2024. 


Governments will still not have realised that partnering with the private sector, rather than vilifying them, is their only option. They’ve created the beast, and it is too late and too expensive for them to destroy it. An election will be 5 months closer, and kicking the landlord class (or, more accurately, the perceived landlord class) will be too much of a vote winner to ignore. 


It might seem quite bleak in the winter this year, depending on the weather. Global food production is still not necessarily stable following the pandemic, although the UK is unlikely to feel much outside of pricing not falling, or even rising, on certain items. 


One more absolute penalty kick – there will still be no clarity on the next step for the Minimum Energy Efficiency Standards, no proper energy infrastructure strategy, and no solution to the ageing electric grid in spite of the number of electric vehicles that will be on the road by the end of the year. All too easy to predict, sadly.


Hope you’ve enjoyed – see you next week, until then – just make sure to Keep Calm and Carry On!


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