“Each morning when I open my eyes I say to myself: I, not events, have the power to make me happy or unhappy today. I can choose which it shall be. Yesterday is dead, tomorrow hasn’t arrived yet. I have just one day, today, and I’m going to be happy in it.” – Groucho Marx, American Comedian
Welcome to the supplement and the hits just keep on coming. We’ve had a big week on the news headlines front (isn’t that always dangerous?) and I want everyone to get their head around a couple of things (and, as usual, put them into context, or at least attempt to).
The first one is relatively simple. Halifax have yet to release their house price index for October (usually takes about a week after the month for them). Nationwide are always first to the punch and publish on the first day of the new month. Nationwide indicated the first fall (0.9%) since July 2021, breaking a streak of 14 months of rises (some above 0.9% monthly), which was the largest fall since June 2020.
“This is it!” the press basically announced. Mmmmmm. Is it really, though? Would that be forgetting to put into the backdrop that the change of administration led to a near-meltdown in the bond markets, costing pension funds many billions of pounds? It would be reasonable to suspect that many people renegotiated, downwards (we certainly have done across our group, and also have encouraged others we are engaged with on a partnership or consultancy basis to do the same – with significant success) – on the back of all of this turbulence.
I believe we are at the old “one swallow doesn’t make a summer” here and wouldn’t necessarily be calling the start of a big slide. Let’s see – the jury is out. The winter months tend to be limp anyway – people are enthusiastic about completing before xmas generally, but transaction volume is always reduced simply because the legal industry grinds to a halt a little over halfway through December and goes into hiding until the new year. My overall feeling is that the market may be a little more robust than the mass media would have us believe.
My one caveat would be that prices on everything have moved far more quickly and in a more volatile way than before Covid – so we do need to be careful when using any kind of “past” as a predictor of the future, when it comes to pace, volatility and the likes. However – blaming this slide in October on the interest rate – for example – which we will come on to talk about – seems naive.
The Bank of England
The other major factor of impact this week is that the Bank of England has held a much-awaited Monetary Policy Committee meeting to set the base rate of interest for the Bank. Markets predicted around a 70% chance of a rise of 0.75% (at the height of the Truss crisis, the expectations were around 1.00% – 1.50% at this meeting, and indeed some were calling for an emergency meeting); and as they often are, the markets were correct. I attempted another one of my utterly audacious and ridiculous “Correct score” predictions (must be my misspent youth, part of which was spent running a betting syndicate) – I predicted 3 at 0.5%, 5 at 0.75% and 1 at 1%.
In central bank parlance, that is 3 doves (rates should be lower, inflation is on the way under control) and 1 hawk (rates should be higher, inflation needs breaking by breaking demand), with 5 in the safety of the middle. I was correct about the split vote – but not the makeup of it. 7 voted for 0.75%, 1 voted for 0.5% and 1 voted for 0.25%. It is the doves here that I’d like to focus on – what are they thinking?
They are thinking that central bank policy takes time to have an impact. This is well established – a typical “impact period” would be 6-18 months when policy changes. Just let that sink in for the moment. 6 to 18 months! Mid 2024 before this rise has worked its way through the system. Why? And with that in mind, what are they thinking in general?
This is what makes me most uncomfortable at the US Federal reserve’s take on this – who also raised policy rates by 0.75% this week. For the fourth time in a row. This meteoric rise is part of the “American Way” – exemplified during covid for example. “Take the pain!” – no furlough, plenty of stimulus, unemployment support very temporarily – and then sink or swim. One benefit for the UK is that we get to watch what the US has done and react accordingly bearing in mind what is similar to the US economy, and what is different, for us.
The outcome of the meetings are always important. They are what hit us in the pocket, or benefit our pocket. Between 2016 and 2021, the impacts were constantly positive. We really need to think of ourselves, IF we were trading during that time period, as being quite lucky. The direction of travel was almost always cheaper money, especially when 2020 hit. It’s better to be lucky than good, they say – and also, we had to work hard to get ourselves INTO the position to BE lucky, but nonetheless – I cannot help but reflect on 2020-21 and feel the deck hit me in the face, somewhat, to use a poker analogy.
Read between the lines
However, I’m most interested in the language used, and trying to read between the lines when reading the minutes, and listening to the webinars. The Bank is fairly clear – the inflation target is still 2% and that’s still the target. Policy guidance allows for significant drift from the 2% in times of volatility, like now – but the spectre of inflation MUST be conquered. In 30 years of “inflation targeting” by several central banks worldwide – the overall conviction is that this is still the way forwards and there are no sensible alternatives that are worthy of a lot of airtime (I am inclined to agree, at this time, although I definitely reserve the right to change my mind!).
The logic is fairly simple to follow. Inflation hurts everyone, for long periods of time. When we are well above target, every alternative is horrible. In the 1970s, it meant that wage demands spiralled upwards, which pushed prices further upwards again as companies had to raise prices significantly in order to try and protect or maintain any sort of margin – to stay in business. Now it means that prices are spiralling upwards due to supply chain pressures and energy costs (and, frankly, opportunistic businesses) and since wages are NOT meeting that pace, people are worse off in real terms. If your adjustments are set annually to your income (and let’s face it, in the absence of getting a new job or a second job, or a new side hustle, the vast majority of people are – perhaps not for the readers of this, but for their tenants, they generally are) then a big rise in prices by December when your pay rise was April, hurts in real time.
The Bank was keen to point out the following facts, some of which won’t make the readers here feel much better. Firstly, far fewer properties actually have mortgage finance against them compared to previous times of rising rates (1990s, 1970s being two very pertinent ones). 36% of all properties are unencumbered owner-occupier – by some way the largest percentage of households (28% encumbered O-O, 19% private rental, 17% social rental). Those who are encumbered, of course, are between 0.1% and 95% leveraged – the overall LTV being around 42%.
What’s the size of the problem?
Within the next 12 months, around 2.5-3 million households (of the nearly 30 million households in the UK) are exposed to variable rates on their mortgages. What they didn’t say is how many of those are in trouble thanks to what’s basically a trebling in their pay rates. Although a 200% rise sounds extremely worrying, we do need to also keep this in context of the fact that the vast majority have passed a stress test with the pay rate at 5.5% or so, and today’s pay rate is currently showing at 5.54% for a 90% LTV 5-year fixed at First Direct (not everyone will qualify for that, of course!) – not much above the stress test level. It could be a non-problem, looking at that. There’s a bucketload under 5.5% for lower LTVs. The issue is volatility of course – those rates are simply today’s rates and things are still moving more quickly than anyone is happy about.
For those on variable rates – unless they are fairly financially sophisticated, it likely means they are not on top of their finances in the first place. What I’m saying is that it isn’t usually a choice to be on a variable rate, more apathy/the end of a fixed product. Throw energy bill increases in the mixer and this causes a problem. The bottom 10% here we can safely assume to be in some trouble, those who struggle to budget – going beyond that, we are speculating somewhat. That’s still 250,000 – 300,000 households in trouble – but compared to the 30 million households, the utilitarian argument from the central bank is of course very powerful. The few get sacrificed to save the many, right?
Around 100,000 are dropping off a fixed rate every month. Some will wait – many will not, and fix at the higher rates, because they have made progress in the past 5 years. Some who have been habitual users of a 2 year product have a double problem – fewer years to make steps forward in wages and career progression, and only 2 years of capital repayments other than 5. A further problem is that the 2 year products are now more expensive than the 5 year ones – because of the shape of the bond yield curve, and the resultant swap market curves, which I have talked about extensively over the past few months. One side-effect here could be the, at least temporary, near-retirement of the 2 year products.
The media storm
How long to see all this make a real difference? Well, we will see what we’ve seen since Covid for sure. “Repossessions up 31247823%” or similar claims by the media. Sure, from 3, back to a meaningful number that would be more typical of a functioning credit market. Can kicked down the road for nearly 3 years – what would anyone expect? Still, it is unlikely to be fast, especially these days with court backlogs. It could still be some time before it happens in a meaningful way in the residential market – commercial and investment repossessions can happen a lot faster of course.
“Raising interest rates won’t fix supply issues” has been an argument for a year or so now. This has some validity – I mean it is self-evidently true – but it misses a nuance. That really isn’t the point. The Bank knows that a side-effect will be to choke off demand as more of people’s money goes on servicing debt, which means consumption comes down. Everyone is surprised (globally) that Europe can cut its energy requirements by 15% – it is amazing what can be done when the chips are down. The problems start more when or if it is asked to do the same level of cutting next year, on top of cuts already made this year – a bit like austerity. The first cut or two make sense, are prudent, and actually can be efficient. The fifth or sixth are simply pushing numbers around on a spreadsheet, squeezing the tube somewhere to cost even more money somewhere else (asylum seekers, social housing, you could pick a dozen examples quickly and easily). False economies.
The Bank doesn’t openly talk about “choking off demand”, of course – what we can take solace in is that there are other weapons that are sensibly back on the table, at least for another couple of years or so. Fiscal policy – the government’s take on taxation and expenditure related issues – is back from the brink of lunacy and can make a difference. We have a week and a half or so until a budget, which will be much more in tune with what the Bank is trying to achieve now.
Tax up? Again? Really?
That budget will include parts of all of the offensive weaponry. Tax rises – that leaves less money in our pockets. The surefire way to reduce consumption, which is the major component of national income, and reducing consumption will inflate the economy less. Producers sell less; they have to cut prices to maintain sales, or make cuts to jobs and hiring. What’s coming down the pipe? I suspect some clever bits that we can’t see just yet, but the direction will be upwards – it is likely that this time, in my view, Capital Gains Tax is moved to the income tax rates – if it does happen for next tax year, there is a window of opportunity for those that can move quickly to close on purchases where vendors are exposed to CGT as it moves from 10%/18%/20%/28% (depending on circumstances) to 20%/40%/45% – that’s some difference to net money in the pocket for people!
It would also, likely, be a popular move since more than 90% of the population simply don’t pay it (I wonder what percentage of the population don’t even know what it is!). The reality of tax when there are large budgetary holes though, of course, is that the attractiveness is always in taxing all of the people or as many as possible – a rise in VAT, for example, whilst unpopular and likely to come in for much criticism – would raise a large amount of money and be considerably disinflationary. This hasn’t been mooted at all, by the way – simply my feelings as a bloodless economist.
Spend a bit less then?
This can deflate the balloon. The other part of the National Income formula (this week’s image) is Government spending, G. That, obviously, is something the Government has a level of control over (not the level of control we would prefer, but still…..). Cutting this is known as austerity – and whilst I’ve openly been opposed to the policy as used in the mid-2010s particularly (as have many eminent economists and think tanks around the world), there are times when it is necessary, and this could be one. Various public sector departments and budgets absolutely ballooned during Covid, and it would be naive to suggest that there is not fat to be trimmed here. I would simply stand by my comments above – the first cut (is the deepest?) can be productive, and perhaps the second – beyond that, it is political jockeying only, and accounting smoke and mirrors, in my view. Cuts here would be disinflationary and that’s needed.
That’s pretty much the toolkit though, folks – that’s what Mr Hunt has in his briefcase. Anything else is some clever smoke and mirrors, that’s all – it will be a variant of one of those.
So – although I love to be “so macro” (in tune with Sinitta, for music fans), it is important to do the “so what” part of the equation. What is there for us to do?
With resi mortgages trading probably 1% above where would be comfortable, it’s fair to say that BTL mortgages are at least that – perhaps more like 1.5% above. Peter Vandervennin, who I often present alongside at our Partners in Property meetings, discussing the Bank of England, the economy and mortgages, has predicted that rates will settle between 4-5% for resi, and 5-6% for BTL. This is being accepted as what the “new normal” will look like – “the era of cheap money is over”. I strongly agree and have been saying this for some months.
Upside shocks and why you must ACT NOW
The miserable economist I am, I am still concerned over upside shocks. The Bank admitted this in their report this week – they see all the risks to the upside on inflation. They are predicting a strong, sharp fall-off in inflation, but I still believe aside from anything else that Mr Putin has significant weaponry in his arsenal before going nuclear, as has been mooted of late. That weaponry is commodities, and whilst gas pipelines have been compromised, we cannot take our eye off the fact that Russia produces around 10 million barrels a day of oil – which is 10% of the global oil supply. That’s gigantic – a 5% drop in global supply would not see a price rise of 5%, but more likely a price rise of 50%, or perhaps more.
That means that taking action NOW is the only way forwards to insulate yourself (no pun intended) from the coming winter. I’m not talking December to February – I’m talking higher rates, higher arrears (inevitable), and higher taxes. Fixing still looks smart if things stack up on that property – if not, active asset management is required in terms of rent increases (as the chatter around rent caps continues), higher cashflowing uses (HMO, short let), changes in tenant types, changes in use class, or, ultimately, disposal.
The beauty of property, remember, is that it IS slow moving. It is safe – where would your money rather be in a recession? Stocks and bonds have taken a different degree of pain this year, more so if you are denominated in dollars – but as the US goes into a proper recession at some point next year, there may well be an adjustment in the dollar price and the markets could easily have further to drop. Cash – well, fine, but in times of inflation, unless you have other things deflating such as nominal fixed debt against assets, you are losing purchasing power and losing wealth. Property will still be safe, deemed safe, and completely necessary for people to live in.
My thoughts on a crash
The chances of a crash are limited in my view, based on the above. Individual losses – yes. Low confidence – yes. Lower transaction volume – an absolute guarantee. But with unencumbered properties and cash balances in savings, and in the bank – so much of the Covid stimulus found its way, eventually, into the pockets of the asset owners (although paper gains are obviously at risk right now) – the probability of a true crash looks low to me.
It’s time to keep it tight – not be a motivated buyer – be patient, but be ready to transact. Don’t shut the doors – that would be naive in the extreme. There’s always great deals to be done, and we are still transacting, offering, following up and trying to create deals and value. We are looking at solid cashflow, safety, and margin. Solving problems for others – how good business is done. A lot of that is unchanged from my ongoing strategy for the past 11 years – some of the numbers have changed thanks to the higher rates, but we are still in business and looking forwards to 2023. Keep smiling, keep sensible, and carry on…..until next week!