Ear to the Ground

June 23 2023

It is difficult to put pen to paper, or should I say fingers to the keyboard, these days without making reference to central banks.  In the previous week it was the US Federal Reserve and the European Central Bank who were in the limelight.  This time it was the Bank of England who were determined not to be outdone.  Meeting on the 22nd June, the market had expected a 0.25% rise.  Instead, the committee voted 7 to 2 in favour of a 0.5% hike, taking interest rates to their highest level since 2008.

Not only that, but policy setters commented that they would not be put off hiking again if necessary.  This was clearly in response to inflation data earlier in the week which was higher than expected.  Here we saw the consumer price index (CPI) hold at 8.7% to May, above market expectations of 8.4% and still considerably above the central bank’s set target of 2%. 

There continued to be an increase in the rate of inflation for items in the CPI basket, such as air travel which stood at 31.4% for the 12 months to May compared to 12.6% the previous month, along with recreational and cultural good and services where the rate of inflation was 6.7% versus 6.3% at the end of April.  There was a slowdown in the rate of inflation for items such as fuel costs and food.  However, the latter still saw price rises of 18.3%.  Of particular worry for the central bank will be core CPI (excluding food and energy) which rose 7.1%.  This was again above the consensus forecast of 6.8% and was the highest level seen since March 1992.

Expectations for further interest rate hikes are now strong.  The Bank of England Sterling Overnight Index Swap Rates (OIS) now show that the UK base rate could reach as high as 6%.  This compares to c. 5.25% which was seen at the beginning of June.  The threat of higher interest rates will undoubtedly be weighing on the mind of UK home owners, in particularly those with a mortgage whereby the deal is due to expire in the not too distant future.  It was perhaps therefore unsurprising to see the UK government hold a meeting with senior mortgage lenders who have agreed that they will implement a 12 month waiting time before they start repossession proceedings against those who cannot afford to pay.

We doubt it is only the UK household owners who are carefully looking over their shoulder, however.  The latest data from the Office for National Statistics (ONS) shows that the level of UK government borrowing reached £2.6trn at the end of May.  For the first time since 1961 the level of debt has risen above economic output.  The last thing the UK needs right now is higher debt servicing costs on top of higher levels of debt, but that is exactly the position which they now find themselves in.

The higher interest rate expectations for the UK, coupled with low growth expectations for the future, now means that we firmly have an inverted yield curve in the UK.  We find ourselves in good company, with the US, German, Canadian and Australian 10 year minus 2 year yield curves also inverted.  Historically a good recession indicator, but when?

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