LONDON (Reuters) – The Bank of England looks set to step into the unknown on Thursday, when it is expected to raise interest rates for the first time since 2007 at a time when growth appears weaker than before any other rate rise of the past 20 years.
Having cut rates to a record low 0.25 percent in August 2016 after Britons voted to leave the European Union, the Bank is now correcting course and falling in line with the U.S. Federal Reserve and the European Central Bank, which are either raising rates or scaling back stimulus.
Whereas the United States and the euro zone are enjoying robust growth, however, Britain’s economy has grown at its slowest pace in more than four years over the past 12 months.
Quarterly growth of 0.4 percent offers the weakest backdrop to any rate rise since the Bank became independent in 1997.
True, inflation is at a five-year high of 3.0 percent, a full percentage point above the Bank’s target, but that is mainly because the pound is an average 11 percent weaker against the currencies of Britain’s main trading partners since the Brexit vote.
The Bank has often overlooked past spikes in inflation if they were caused by currency fluctuations that were deemed to be temporary.
Inflation is set to fall this time too, but only slowly, as the Bank judges domestic inflation pressures are pending.
Partly due to stagnant productivity since the 2008 financial crisis – and partly due to concerns about the effect of Brexit on immigration, trade and investment – BoE Governor Mark Carney thinks the economy cannot grow as fast as it has in the past without generating excess inflation.
“We’re in a new paradigm,” says George Buckley, an economist at Nomura who was one of the first to sense a change at the central bank earlier this year, when most economists were saying they did not expect rates to rise until 2019.
Raising rates now would be the biggest call on monetary policy Carney has made as governor, and may shape his legacy.
Carney has faced criticism from economists who say his past guidance on monetary policy has been unhelpful, and from Brexit supporters who say he is too focused on the risks of leaving the EU. But until recently his broad approach to interest rates has been fairly uncontroversial.
For most BoE watchers, the likelihood of a rate rise only became clear in September, when minutes of the nine-member Monetary Policy Committee’s meeting that month showed underlying price pressures were no longer a minority concern.
Two policymakers voted for a rate rise, and a majority of the others said they expected to do so “over the coming months”.
RAISING RATES “MAD”
Almost all economists polled by Reuters last week expect the Bank to raise interest rates to 0.5 percent from 0.25 percent on Thursday. Most do not expect another one next year and 70 percent said even one rate rise would be a mistake. The latter view is common in markets, too.
“Personally, I think it would be mad,” Jim McCaughan, chief executive of Principal Global Investors, which manages $430 billion of assets, told Reuters earlier this month.
“You’d be tightening at a time of economic softness to defend against a weakness in sterling that you need (to boost exports).”
The Bank says its policy decisions are not driven by exchange rates. When Carney gives his news conference at 1230 GMT on Thursday, he is likely to focus on a 42-year low in unemployment and how it heralds more upward pressure on wages and inflation.
The Bank has been here before, however. Unemployment has repeatedly fallen further than the BoE forecast in recent years, while wage growth has remained stubbornly around 2 percent, half the 4 percent rate associated with pre-crisis rate rises.
Investors will be keen to glean what is meant in practise by the Bank’s long-standing stated expectation that it will only raise rates “at a gradual pace and to a limited extent”.
Markets have priced in an almost 90 percent chance of a rate rise on Thursday, but then expect the Bank to wait until late 2018 before raising again, Nomura’s Buckley said.
He said that was probably too long for the BoE’s tastes. On the other hand, however, Carney will not want to box himself in or lead the wider public to believe he plans to return rates to their pre-crisis level of around 5 percent.
Economists do not expect one or two rate rises will hurt growth much unless businesses or the public think many more will come and curb spending as a result.
BoE forecasts showing inflation is still expected to exceed its target even after three years might be the clearest sign that the Bank thinks faster rate rises are needed, Buckley said.
Either way, the stakes are high both for the Bank and its governor, who has said he will step down at the end of June 2019.
“If he presides over a tightening of monetary policy and it slows down the economy, that’s what he will be remembered for,” McCaughan said.
LONDON, (Reuters) – Britain’s housing market and consumer economy kept most of their momentum last month, lending figures from the Bank of England showed on Monday, leaving the central bank on track to raise interest rates for the first time in more than a decade on Thursday.
The number of mortgages approved for house purchase fell to a three-month low in September at 66,232 from an upwardly revised 67,232 in August, slightly above economists’ average forecast for it to slip to 66,050 in a Reuters poll.
The growth rate in unsecured consumer lending nudged down to 9.9 percent on a year-on-year basis in September from 10.0 percent in August, matching July’s growth.
In cash terms, net consumer lending rose by 1.606 billion pounds last month, a fraction above the highest forecast in a Reuters poll.
Last month the BoE said British lenders needed to hold an extra 10 billion pounds of capital to guard against consumer loans going sour, as it was concerned that banks had overestimated the creditworthiness of their borrowers.
Government data on Friday showed that personal insolvencies rose to a five-year high in the third quarter.
Official data last week showed an unexpected pick-up in gross domestic product growth to a quarterly rate of 0.4 percent in the third quarter – still well below its long-run trend, but an improvement after the weakest first half since 2012.
Moreover, with inflation at a five-year high of 3.0 percent and unemployment at its lowest in more than 40 years, the BoE looks on track to raise interest rates on Thursday for the first time since 2007, reversing a rate cut made in August 2016.
The initial impact of raising rates back to 0.5 percent – their level for seven years until August 2016’s rate cut – may be muted for most Britons.
Less than 30 percent of households have mortgages, and 60 percent of these are fixed-rate, compared with just 30 percent 15 years ago. For the average borrower with a variable rate mortgage, interest payments will rise by 180 pounds ($237) a year if rates return to 0.5 percent, according to mortgage lender Nationwide.
Mortgage lending, which lags behind approvals, rose by 3.848 billion pounds in September and is 3.2 percent higher on the year. Mortgage and consumer lending combined is up 4.0 percent.
Britain’s housing market has slowed since June 2016’s vote to leave the European Union, especially in London and neighbouring parts of England.
Markets have a tendency to panic when central banks threaten to raise interest rates. In 2014, the US Federal Reserve and its then boss, Ben Bernanke, senttraders across the world into a spin when he merely hinted that the era of almost zero rates might be ending.
It’s been a decade since the Bank of England last increased the cost of borrowing, so it is no surprise that this week’s vote by the monetary policy committee, which Threadneedle Street has sketched out as a good moment for a rise, is being closely watched.
Nine committee members hold the key to unlocking 10 years of ultra-low rates – with five drawn from the Bank’s payroll and four external members from industry and the City. The latter serve a three-year stint, which is often extended to six years.
Bank of England governor Mark Carney is among many on the MPC to have hinted that 2 November will be the day the Bank should at least reverse its emergency 0.25% set in August 2016, which was designed to ensure that the economy did not take a dive in the wake of the Brexit vote. And having listened to one carefully coded hint after another in recent months from what is clearly a majority of members, markets have judged that an increase is now almost nailed on – with a 90% probability.
However, the case for a rate rise, as Carney and his colleagues always stress, is finely balanced and could go either way once they have sieved through all the economic data. Here we consider the arguments for raising them versus the reasons to hold steady.
The case for higher rates
The Bank of England was set two targets when it was reconstituted by Gordon Brown in the late 1990s and granted the power to set interest rates independently: to maintain inflation at around 2% and to make sure that monetary policy kept the economy’s wheels turning.
In the past 10 years these have proved to be conflicting aims, because to raise rates has been seen as an almost certain way to kill off growth. That wouldn’t be the case in more normal times, but in the aftermath of the banking crash, with lenders initially strapped for funds and regulators concerned to keep the financial sector on a tight rein, low interest rates were seen as the only way to keep money flowing around the economy. And that is especially true when so much household spending is based on borrowed money.
So the second concern – to keep GDP expanding – has won out over the imperative to maintain inflation steady at 2%, and inflation has been allowed to soar to 5% – as it did in 2012, when the Bank sat firmly on its hands and did nothing.
Forecasts for inflation don’t show it going back to 2012 levels, but with a rate of 3% recorded in September and predictions of rises for at least the next couple of months, the Bank must consider increasing the cost of borrowing to reduce the demand for goods and services, and calm price rises.
Further price increases could already be in the pipeline, according to some MPC members, following the fall in unemployment to 4.3% in the three months to August. As Howard Archer, chief economic adviser to the EY Item Club, says, the joblessness rate is at its lowest since 1975 and well below the 4.5% equilibrium rate the Bank believes determines full employment and is the trigger for higher wages. With more money in their pockets, workers could be tempted to borrow and spend even more, adding to the pressure on prices.
It’s not just jobs: the economy has held up much better than most forecasters, including the Bank, predicted following the Brexit vote. It has grown throughout the year – when many thought it could fall into recession – after three previous years of growth. If the Bank won’t raise rates against this backdrop, then when?
Some economists also believe the bank should take the opportunity to raise rates now because it may need to cut them again the future. At 0.25%, the bank has no real leeway for a cut that would act as a stimulus. By raising rates – maybe once, maybe more – Threadneedle Street starts to rebuild its ammunition for use in a crisis.
And then there is the question of pride. This is a huge factor after months during which the Bank has prepared the ground for a rate rise. As Archer says: “If it fails again to follow through with a rate hike, it will risk losing credibility.”
It would also probably prompt a fall in the pound – which would stoke inflation even further.
Carney’s reputation as a modern-day Grand Old Duke of York is under particular scrutiny. He has used speeches and reports in the past to tell businesses and households that higher borrowing costs are imminent – only to retreat back down the mountain. It could be that his influence will wane should he refuse to make good on yet another threat.
The case for the status quo
The economy may have grown for almost four straight years, but the rate of growth has declined since its initial burst in late 2013 and is now the lowest of all major economies. Next year, the OECD says Italy and Japan, often derided as the zombie economies of the developed world, will grow faster than the UK.
Last week the Office for National Statistics said Britain grew by 0.4% in the third quarter of the year, compared with 0.3% in the first two quarters.
The MPC’s newest recruit, Sir David Ramsden, formerly the Treasury’s chief economic adviser, said in his confirmation hearing that given rates of growth almost half what they were in 2015, the economy was too weak to withstand higher borrowing costs.
With the government seeking to cut back on borrowing, and large corporations hoarding enough cash to avoid the need to borrow, driving up the cost of loans to consumers and small businesses could push the economy further towards zero growth.
Brexit is another reason to err on the side of caution and keep rates where they are. Consumers have already become more circumspect with their spending. High street surveys show consumers keeping their wallets shut unless there is a good reason to open them. The CBI’s latest figures showed the steepest fall in retail spending since the depths of the post-banking crisis recession in 2009. High street bellwethers John Lewis and Debenhams have both warned of challenging trading. Car sales have already plummeted, as have sales of furniture. According to the Halifax, confidence in the housing market is at a five-year low.
Chris Williamson of economics consultancy IHS Insight says the “slow erosion of growth” may continue. He points out that across all sectors of the economy, inflows of new business in September were at their lowest for 13 months, suggesting that demand for goods and services “has waned again”.
Business optimism is weak, he adds, which is another indication that businesses are about to suffer a further drop in activity and that the economy will slow “towards stagnation at best”.
Archer of the EY Item Club believes inflation is set to fall back markedly from around the turn of the year as the impact of past sharp falls in sterling fade. The weak pound has seen many businesses suffering a large rise in import costs, which a number have absorbed through lower profit margins and passed on to workers through sub-inflation wage rises. Nevertheless, prices have crept up. Without further falls in sterling, prices will stabilise on their own. An interest rate rise in this situation could make a bad situation worse.
It’s a danger Ramsden has been explicit about wanting to avoid. But pushing an already struggling economy, dogged by Brexit-related uncertainty, towards recession is not something any MPC member will want to be remembered for.
Where the MPC stands
Gertjan Vlieghe External member
A former hedge fund economist, Vlieghe, an external member of the MPC, said in August: “This is an environment where a premature hike would be a bigger mistake than one that turns out to be slightly late.” Last month he said the mood was changing: “The appropriate time for a rise in bank rate may be as early as in the coming months.” How hawkish? 8/10
Silvana Tenreyro External member
A former professor at the London School of Economics, Tenreyro is a new appointee. At her first public engagement last month, she said: “We are approaching a tipping point when we will need to reduce some of that stimulus.” She added that unemployment still needed to be lower: “A premature increase might be very contractionary, so a mistake there might be very costly.” How hawkish? 6
Michael Saunders External member
Former Citibank economist Saunders voted for a rise in September, to dampen looming price pressures. In August he said: “Our foot no longer needs to be quite so firmly on the accelerator in my view. A modest rise in rates would help ensure a sustainable return of inflation to target.” How hawkish? 10
Ian McCafferty External member
The former chief economic adviser at the CBI voted in July to raise the base rate from 0.25% to 0.5%. He has voted for a rise ever since, arguing that the “pick-up in inflation is not something we can just ignore”, especially when the “healthy performance of businesses in the past year shows the UK economy could cope with higher interest rates”. How hawkish? 10
Andrew Haldane Chief economist
Haldane was once a fervent supporter of low interest rates, but in the summer hinted that he was more inclined to start pushing them higher. In June, he said a partial withdrawal of the emergency post-Brexit package of an interest rate cutand an extra £60bn of quantitative easing “would be prudent relatively soon”. How hawkish? 6
David Ramsden Deputy governor
In charge of markets and banking, the former Treasury economist says slowing growth and declining real wages mean now is not the time for a rate rise. He said last month: “Despite continued robust growth in employment, there is no sign of second-round effects [demands for higher pay] on to wages from higher recent inflation.” How hawkish? 2
Jon Cunliffe Deputy governor
In charge of financial stability at the Bank, Cunliffe is one of the committee’s most risk- averse members. Last month he told the Western Mail that the UK economy had “clearly slowed”, and that any rate rises would be gradual. As he put it: “The exact timing of when that starts? Well, that for me is a more open question.” How hawkish? 4
Ben Broadbent Deputy governor
Responsible for monetary policy, Broadbent is a close confidant of Carney and keeps his cards close to his chest. In July he stressed the weakness of the economic outlook, saying: “It is a bit tricky at the moment to make a decision [to raise rates]. I am not ready to do it yet.” How hawkish? 6
Mark Carney Governor
Carney is expected to vote for a rise after saying in September that the “possibility has definitely increased”. To give a little more context to his decision, he said: “The majority of committee members, myself included, see that that balancing act is beginning to shift, and that … to return inflation to that 2% target in a sustainable manner, there may need to be some adjustment of interest rates.” How hawkish? 6
Confidence in the UK housing market has slipped to its lowest level in five years, sounding renewed warnings over the health of the economy.
One in five British adults surveyed by the Halifax bank expect house prices will fall in the next year, in the weakest reading for consumer expectations since October 2012. Young people under the age of 25 and those living in London are found to be least optimistic.
The drop off in confidence comes amid growing concerns over the strength of the economy, with rising inflation and weak wage growth putting pressure on British households. It also comes as the Bank of England prepares to raise interest rates for the first time in a decade from as early as next week.
Despite the looming increase in the cost of borrowing, gathering a deposit is viewed as the biggest barrier to buying a home. According to the survey of almost 2,000 British adults, almost two-thirds see this as the main barrier, whereas just 15% worrying about the availability of mortgages or concerns about higher interest rates.
Of the 535 mortgage holders questioned in the survey, only a third said they were anxious about rising interest rates affecting their ability to meet repayments. This was down from 42% in 2014.
The survey also shows concerns over personal finances rising up the list of potential barriers, while job security was found to be a major worry among those looking to buy a home. The average house price stood at £222,293 in August.
The lowest levels of unemployment since the mid-70s are still failing to boost the bargaining power of employees in the UK, according to the latest official figures. When taking account of inflation, real wages fell by 0.4% in the three months to August, the sixth consecutive month of negative earnings.
London was the only region in the Halifax survey where the balance of people thought it was a bad time to buy, with those in the West Midlands and Wales the most positive. Those aged between 16 and 24 were the only age group with a negative buying outlook, while those over 65 were the most positive. Across the UK about half of those surveyed thought it would be a good time to buy.
Russell Galley of Halifax said: “Housing market optimism has declined significantly over the past year, with almost half of people expecting a general slowdown in the market.”
IN A meeting room on a cold autumn day, the governor of the Bank of England settled into a witness chair to give evidence to a group of MPs. Worries were mounting about the economy. GDP growth was slowing and households were highly indebted. Nonetheless the Bank of England began raising interest rates. The governor told everyone to relax. Concerns about a “Christmas debt crisis” caused by higher rates were overblown, he said: “People have exaggerated the vulnerability of the economy to likely changes in policy.”
That was in 2003, when Mervyn King was the bank’s governor. For the first time since then, and under a different boss, Mark Carney, the bank is expected to start raising interest rates once again, after a long period of inactivity (see chart). Inflation is 3%, well above the bank’s 2% target. GDP grew by 0.4% in the third quarter, above expectations. As in the early 2000s, members of the bank’s monetary-policy committee (MPC) are coming round to the view that tighter monetary policy will have a benign effect on the economy. Are they right?
By raising or cutting the benchmark interest rate, the MPC influences the rate at which high-street banks can borrow—and, in turn, the borrowing costs faced by households and firms. In the post-war period it averaged around 6%. Yet during the crisis of 2008-09 the bank slashed it to stimulate the economy. It was cut again after last year’s Brexit referendum, to 0.25%, the lowest on record. Most economists believe that on November 2nd the MPC will change direction and raise it to 0.5%.
The reaction of the economy as a whole to tighter policy will be largely shaped by how households respond. Their spending accounts for some 60% of GDP. At first glance, Britain’s households look prepared for what is to come. True, the stock of household debt (mortgages plus consumer credit) is nearing 140% of income, which is high by historical standards. Higher interest rates would result in higher payments for those with debts. They would have less money left over for everyday expenses.
However, many Britons would also earn more interest on their savings, which are worth around 120% of income. That would give them more spending power. A rise of 0.25 percentage points in the base rate, passed on fully to savers and borrowers, would cost less than 0.1% of incomes. No big deal.
Yet such a calculation understates the probable impact of higher interest rates. For one thing, the circumstances are unusual. The bank’s “inflation-attitudes survey” suggests that when it has tightened monetary policy in the past, the public has inferred that further rises are on the way. The bank has tried before, and failed, to forestall such a reaction. The last time the MPC raised rates, it stressed that “no immediate judgment was being made about the future path of rates.” No matter: subsequently, a big majority of the population thought that further rises were likely.
The public’s reaction is especially hard to predict this time around. Interest rates used to go up and down frequently. Today, after a decade with no rate rise, many adults are familiar only with the Bank of England cutting the cost of borrowing. If people start to worry that their incomes will be squeezed more tightly still in the coming months, then consumer confidence and spending could fall by more than the MPC expects.
The effects of higher interest rates will also be unevenly felt across households. Some have plenty of savings, others have big debts. Few have both. Data on the distribution of assets and liabilities are poor. What evidence there is, however, makes for uncomfortable reading.
One worry concerns those who would benefit from higher interest on their savings. Income-bearing financial assets are unequally distributed. Such inequality also runs along generational lines. What will the wealthy do with the extra income from their savings? People with large pots are by definition squirrellers, not splurgers. Retirees have a recent additional incentive to save any windfall. The inheritance-tax regime is becoming increasingly generous: by 2020 a couple will be able to leave £1m ($1.3m) tax-free to their children, if it includes their house, up from £650,000 last year. All this suggests that the boost to savings from higher interest rates is unlikely to translate into much extra spending.
On the other side of the equation, households with heavy debts may struggle with higher rates. Britain’s pile of mortgage debt is concentrated among far fewer households than it was a decade ago. Prospective buyers have to stretch to get a foot on the housing ladder. Since 2012 the average mortgage for a first-time buyer has equalled 3.4 times their income, up from 2.6 times at the turn of the millennium.
Many have locked in low rates on these mortgages with fixed-rate products. Such deals typically last for between two and five years, however, not the 30 years that is common in America. And of all outstanding mortgages, roughly 40% are on variable rates. Our analysis suggests that, because mortgages have become so hefty, a given interest-rate rise would ultimately result in a bigger squeeze on recent homebuyers’ income than at any other time on record.
Poorer Britons could also suffer. Lately the rate of personal insolvencies has risen, in part because of tough welfare policy and falling real household incomes. Those whose incomes have been squeezed often rely on short-term loans to tide them over. If the cost of repayment rises, more might struggle. Indeed, a survey in the bank’s latest inflation report found that, after a hypothetical decline in real incomes, “households who would reduce real spending the most tended to have fewer savings and be more concerned about their debt.”
Whatever happens next week, rates will remain low, meaning that monetary policy will continue to favour borrowers over savers. But in shifting the balance, the bank must tread carefully. It has signalled that interest rates will rise only at a snail’s pace—perhaps 0.25 percentage points every year. A more rapid increase could prove to be an unwelcome jolt.
London’s commercial property market outlook is more subdued than elsewhere in the country, with the capital bucking the UK trend for rising demand from investors and occupiers.
Almost three quarters of respondents to a survey by the Royal Institution of Chartered Surveyors (RICS) warned the market may be in some stage of a downturn, when outside of the capital, expectations were generally positive for office, retail and industrial rent.
The survey of 347 of RICS’ commercial property members found that negative sentiment regarding office and retail rent cancelled out positive expectations for industrial rent in the capital.
In the near term, London is also displaying more cautious sentiment, with weakening occupier demand producing negative rent expectations, while availability has picked up, as have inducements.
When it comes to the investment market, RICS said trends appear a bit more resilient, but headline capital value expectations are now more or less flat.
The central London market also had the highest proportion of respondents viewing it as overpriced to some extent, at 67 per cent.
Simon Rubinsohn, RICS’ chief economist, said:
The underlying momentum in the occupier market remains a little more challenging in the capital than elsewhere with rents expected to remain under pressure away from the industrial sector. This is also mirrored in valuation concerns, with around two thirds of respondents viewing the London market as being expensive.
Despite this, foreign investors continue to view London in general and the office sector in particular as an attractive home for funds.
Rubinsohn said a particular issue going forward will be how the market responds to the “likely first interest rate rise in a decade next month”.
He said: “Given that expectations are only for a modest tightening in policy, the likelihood is that it will be able to the weather the shift in the mood music. But this remains a potential challenge if rates go up more than is currently anticipated.”
LANDLORDS of houses of multiple occupation [HMOs} and commercial dwellings with flats above shops faced a surprise earlier this month (Tuesday 3 October) during a council crackdown.
Officers from the Council’s housing, food safety and waste enforcement teams along with officers from Essex Police visited 80 homes suspected to be operating as unlicensed HMOs.
After the day of action, three licensable HMOs operating without a license, 18 non licensable HMOs, four landlords for planning and building enforcement prosecution and three empty homes were found and seven Environmental Protection Notices were served on local businesses.
Portfolio Holder for Housing, Cllr Rob Gledhill said: “Houses of Multiple Occupation Landlords are currently subject to mandatory licensing for three storey buildings occupied by five persons in two or more households.
“This currently limits the number of properties under this scheme but I am anticipating that the requirement is going to be extended by the government to include all properties with five or more people in two or more households meaning the 18 non licensable HMOs identified during the day of action will fall under this category next year.”
Letting a licensable HMO without a licence is a criminal offence and can result in an unlimited fine upon conviction. Persons managing or having control of a licensable HMO without a licence may also, in certain cases, have to repay rent. This applies to rent paid by tenants or by local authorities in housing benefit.
Cllr Gledhill added: “I would like to thank all those taking part in this operation to show we take this issue seriously. This was a coordinated effort to tackle poor performing landlords of HMOs and flats above shops where tenants are complaining to us about living in poorly maintained homes.
“`While we recognise that most private landlords comply with regulations and offer a good service to their tenants, it is important that we deal robustly with those in the sector who fall short of these standards.
“We are looking at extending licensing to include small HMOs in certain parts of the borough associated with anti-social behaviour and poor health and safety conditions to ensure that minimum standards are being met.”
If you have information about an unlicensed HMO, you can give us details by e-mailing firstname.lastname@example.org or visit: thurrock.gov.uk/houses-in-multiple-occupation for more information.
November’s interest rate decision is fast approaching and, with recent data having shown the UK economy at risk of a slowdown, strategists are increasingly divided over what to expect from the Bank of England.
Those hoping for a retreat from earlier warnings over UK interest rates may be left disappointed in the wake of the Bank of England’s November monetary policy announcement.
A solid majority expect the Bank of England to hike rates in November while less than half of strategists expect it to follow through with further policy action in the months after.
“There is an argument doing the rounds that the UK is raising rates so that they can cut them when the ‘inevitable’ Brexit-related collapse happens. Maybe,” says Ben Powell CFA, a multi-asset class content salesperson at Swiss bank UBS.
The bulk of those who do not subscribe to the Brexit collapse view have often cited growing concerns over FX-induced inflation as the motivator behind what is, according to them, likely to be limited policy action.
“At 4.5% UK unemployment is at lows not seen in 5 decades. UK asset prices are booming. In 2016 UK household wealth rose by ~GBP900bn to beyond GBP10Tr for the first time. That ~GBP900bn growth is around 50% of GDP,” says Powell.
But UK economic fundamentals have remained on a sound footing since the Brexit vote in June 2016, despite the prevailing narrative in much of the media and most parts of the financial world.
“UK borrowing has never been cheaper. Outstanding resi mortgages cost 6% 10 years ago and 2.7% now; new lending is at 2.3%. Nearly half of today’s unsecured personal loans cost less than 5%; Sainsbury’s and Tesco’s banking arms are advertising unsecured loans at ~3%, some for up to 10 years in duration,” wrote Jason Napier, an equity research (banks) analyst at UBS.
With the market’s eyes fixed keenly on a deterioration in UK consumer spending that has weighed on economic growth over recent quarters, the “emperor’s well clothed state” has gone unacknowledged by the majority.
“Clearly it’s a matter of judgement, but it may be the case that the Governor thinks supermarkets offering 10 year unsecured loans for ~3% feels a bit punchy. There is also a boom in car financing,” says Powell.
Bank of England governor Mark Carney said in a September speech that UK banks have been extending too much credit to consumers at insufficient rates of interest and that the more “frothy” parts of the market should be addressed.
“This is what the data suggests. And it is what the Governor is telling us he is doing. My sense is that those hoping for a ‘dovish hike’ next week are going to be disappointed,” says Powell.
Pound to Be Left High and Dry Says JPMorgan
The Pound Sterling is at risk of being left high and dry against the Euro and other G10 counterparts over the coming weeks as the interest rate tide that buoyed it through September recedes further.
Bank of England policymakers may not be able to do enough to keep it afloat even if they do vote to hike rates at the November meeting, according to strategists at JPMorgan, who are still betting against the Pound-to-Euro rate.
“Our highest conviction macro trade in recent weeks has been short GBP as we felt that UK rate hikes were overpriced given the weak starting point for UK growth and the existential Brexit shock that continues to dominate the medium-term outlook,” says Daniel Hui, a foreign exchange strategist at JPMorgan.
The foreign exchange team at the US bank say the UK economic backdrop made it difficult enough as it was, in September, to justify embarking on an interest rate hiking cycle but observe that the economy has shown signs of slowing further since then.
“BoE expectations have come under pressure this from a combination of lacklustre growth data releases (annual growth in retails sales is now close to 1% compared to +4% when the BoE eased policy last year) together with a stream of commentary from MPC members that reveals a greater range of opinion about the timing of any monetary tightening,” says Hui, in a note written Friday.
The Pound was buoyed in September when the Bank of England said it begin withdrawing stimulus (hiking rates) over the coming months if inflation strayed further north of its 2% target and the economy remained on a steady footing.
By the end of that month the British currency had posted the strongest performance of all those in the G10 basket as traders rushed to price in a Bank of England hike in November and further action to come in 2018.
“The rate market has belatedly begun to rethink its scenario of a relatively normal rate hike as a result of more equivocal commentary from the BoE and the absence of lift in the growth numbers,” says Hui. “Next week’s 3Q GDP print is expected to confirm the UK as the clear growth laggard within G10, and so maintain the sense of drift in rate expectations and GBP.”
The BoE is expected to raise the bank rate by 25 basis points on November 02 but the number of voices questioning whether this is the right thing to do has grown in recent weeks.
“But it’s important to recognize that a less assertive BoE outlook is not the only factor weighing on GBP, as we interpret GBP’s recent moves as reflecting not only a partial retrenchment of priced hikes, but also the additional leverage of GBP to lack of progress in the Brexit talks and the increased risk of an accidental no deal,” writes Hui.
Hui notes the recent signs of progress in Brexit negotiations but flags that trade and transition talks are unlikely to begin until December at the earliest, the atmosphere around talks may remain uncomfortable for the foreseeable future and risks around sentiment to the Pound will remain high.
The Pound received a boost over the course of Friday and Monday after October’s European Council summit concluded with Brussels sounding a more conciliatory tone on the subject of Brexit negotiations, which revived hopes that “sufficient progress” could soon be made for negotiations to move onto the subjects of trade and transition.
“Our largest net position is long EUR against USD, GBP and CHF. The ECB taper announcement is expected to be marginally constructive for EUR,” says Hui. “But we don’t expect fireworks as the ECB will emphasise dovish forward rate guidance to anchor Bund yields despite what could be a sharp slowdown in the run-rate of asset purchases. EUR upside will be a grind.”
The Pound-to-Euro rate was quoted 0.04% higher against the Euro at 1.1237 during early trading in London Tuesday while Sterling was marked 0.08% higher at 1.3215 against the Dollar.
A senior Cabinet minister has said the Government should borrow money to invest in hundreds of thousands of new homes in what appears to be a significant shift in Conservative thinking.
Communities Secretary Sajid Javid said ministers should take advantage of record low interest rates to deal with the housing crisis, which is “the biggest barrier to social progress in our country today”.
Asked if Chancellor Philip Hammond was on board with the idea a month away from his Budget, Mr Javid told BBC One’s Andrew Marr Show: “Let’s wait and see what happens in the Budget”.
But his call to borrow more cash to pay for spending on housing and other infrastructure appears to echo Labour’s own “fiscal credibility rule”, which states that the government should not borrow for day-to-day spending but be prepared use it to fund long-term investment.
Asked whether there would be a new housing fund to build homes, Mr Javid said: “We are looking at new investments and there will be announcements.
“I’m sure at the Budget, we’ll be covering housing but what I want to do is make sure that we’re using everything we have available to deal with this housing crisis.
“And where that means, so for example, that we can sensibly – you borrow more to invest in the infrastructure that leads to more housing – take advantage of some of the record low interest rates that we have, I think we should absolutely be considering that.”
He added: “I would make a distinction between the deficit which needs to come down and that’s vitally important for our economic credibility and we’ve seen some excellent progress, some very good news on that just this week.
“But investing for the future, taking advantage of record low interest rates, can be the right thing if done sensibly and that can help not just with the housing itself but one of the big issues is infrastructure investment that is needed alongside the housing.”
Mr Javid also suggested the Government would not relax protections for the green belt.
“There is a lot more that can be done, density is a big issue – if you look at the density of London for example, it won’t surprise your viewers to learn that London has some of the highest levels of demand in the country, the density in London is a lot lower than many other cities, Paris, Berlin, compared to most cities around Europe, so that’s one area where you can expand more.”
At the Conservative Party conference this month, Theresa May pledged to “dedicate” her premiership to fixing Britain’s housing crisis as she announced an extra £2 billion for affordable housing.
An extra 25,000 social homes could be built under the plans outlined by the Prime Minister but her promise was overshadowed by her mishap-strewn conference speech and subsequent Tory infighting, and the party remains under pressure to do more.
Environment Secretary Michael Gove appeared to back Mr Javid’s suggestions, tweeting that he was “v impressive on #Marr”.
Shadow housing secretary John Healey said: “If hot air built homes, ministers would have fixed our housing crisis.
“Any promise of new investment is welcome, but the reality is spending on new affordable homes has been slashed since 2010 so new affordable house building is at a 24-year low.”
Friday’s boost to the Pound comes closely on the heels of a sluice of bad news for the UK economy, which has recently seen consumer spending fall and the outlook for consumer credit deteriorate further.
The Pound rose strongly throughout the morning session Friday as October’s European Council summit looked set to conclude on a positive note.
Comments from German Chancellor Angela Merkel, Prime Minister Theresa May and a host of other officials were behind the lift, all of which seemed to suggest Brexit negotiations may soon move forward onto the subjects of trade and transition.
“My impression is that these talks are moving forward step by step,” Merkel told reporters. “From my side there are no indications at all that we won’t succeed.”
Markets have feared a possible delay to the progression of talks on to the subject of trade beyond December.
PM May reiterated her Florence promise that the EU will not suffer a budgetary black hole during the current spending period, as a result of Brexit, which runs into 2020.
“There is still some ways to go on Brexit,” says Theresa May. “I am ambitious and positive about the Brexit negotiations.” She also reiterated that the UK will “honour our commitments.”
Any delay of trade or transition talks beyond December is seen as raising the risk of a so called “hard Brexit”, or a “no deal Brexit”, given the time it is likely to take to agree details of a “transition deal” as well as the future relationship.
Despite a rise in the headline measure, the latest borrowing figure was the lowest of any September month for a decade.
The Pound-to-Euro rate had risen 0.43% to 1.1145 a short time ahead of noon while the Pound-to-Dollar rate added 0.08% to 1.3159, making Sterling the best performer against the greenback out of the G10 basket.
Despite this, economists still see consumer spending as having stabilised during the third quarter and are also predicting a steady performance from the economy during the period.
However, with inflation pressures already dampening spending, the outlook for consumers and credit supply to households appeared to darken further on Thursday.
“UK household debt levels are high and still growing,” says Annabel Schaafsma, head of Moody‘s EMEA consumer surveillance team. “As real income declines, UK consumers are vulnerable to an economic downturn and any increases in inflation or interest rates could cause problems for household finances, especially for those on lower incomes.”
Moody’s, the ratings agency, said the faltering outlook for the UK consumer will have an impact on credit providers who support their business using the securitisation market.
“Additionally, consumer credit has been growing in excess of the rate of household income. This suggests we will see a weakening future performance of some UK consumer securitisation deals,” says Schaafsma.
Securitisations are an important source of liquidity for banks of all sizes and also for some corporates. Even mobile phone contracts can be securitized and sold on to investors, unlocking capital and providing an instant return for originators.
However, investor demand for UK securitization deals looks set to weaken, particularly in the mortgage market.
“Moody’s expects higher delinquencies in newer, non-conforming RMBS, as opposed to older, more seasoned deals. The borrowers in newer deals are more likely to be paying higher interest rates and have a smaller safety net. Buy-to-let RMBS is very sensitive to a weaker economy and occupancy rates and rents are expected to decline,” the ratings agency says in a statement.
Bank of England Credit Survey Points To Tighter Supply
Recent BoE changes to bank capital requirements for different types of consumer loans had been expected to slow the pace of lending to households during the months ahead.
But a rise in default rates over the third quarter looks as if it might accelerate the pace at which banks now cut back lending to consumers.
“Default rates on credit card lending were reported to have increased slightly in Q3, while those on other unsecured lending increased significantly,” the Bank of England says, in its latest quarterly Credit Conditions survey. “Lenders reported that the availability of unsecured credit to households decreased in Q3 and expected a significant decrease in Q4.”