Investment Comment
23rd June 2023
Nightmare on Threadneedle Street
Seven years on from the fateful referendum and the UK is diverging not just from the European Union but is increasingly an outlier from the rest of the global economy. Stubbornly high inflation has forced the Bank of England to increase the pace of interest rate rises as they attempt to tame inflation, but at what cost to homeowners and the wider economy.
A double whammy of bad news on inflation and the public finances hit the UK this week before the Bank of England even met. The latest data from the ONS (Office for National Statistics) showed that inflation remained at a higher than expected 8.7% in May, the fourth month in a row that prices have topped forecast, and the “core” measure (excluding volatile items such as food and energy), rose to an eye-watering 7.1% (a 31-year high). UK inflation remains much higher than the EU’s 6% and 4% in the US. This surge in core inflation and the reacceleration in wage growth suggests that domestic inflationary pressures are still strengthening and leaves the UK “looking increasingly like the global outlier and the stagflation nation", according to Capital Economics, an independent economic research business based in London.
Headline inflationary pressures are falling as energy prices ease.
Source: Bloomberg YoY= Year on Year
The UK is an outlier with core inflation still accelerating
Source: Bloomberg
The ONS also released data showing that UK debt has risen above 100 per cent of Gross Domestic Product (GDP) for the first time since 1961 after public sector borrowing doubled in May. Another unwelcome century after the Ashes series kicked off with a loss.
Against this backdrop, the Bank of England’s Monetary Policy Committee (MPC) met to discuss and decide on the level of interest rates. Market expectations had been for a further 0.25% rise, but with the inflation data fresh in their minds they elected to double that, bringing interest rates up to 5%, a level not seen since before the Global Financial Crisis of 2008. With a corresponding increase in mortgage rates, the Bank of England (BoE) rapidly made themselves public enemy number one in a crowded field. Although, as the BoE won’t be on the ballot paper at the next election, this remains a significant issue for the government. With the public finances challenged and no desire to fan the inflationary flames, those looking for government help as mortgage costs rise sharply are likely to be disappointed.
Markets have moved quickly to price in further rate rises and now expect interest rates to rise above 6% by year-end. Whether the Bank of England is prepared to inflict this level of pain on the economy remains to be seen. Although UK economic activity has been better than expected this year, the economy remains fragile under the impact of cumulative interest rate rises and it is only as debt is refinanced that the economic pain is felt. With a wall of mortgage refinancing coming due throughout the rest of the year, there is a growing risk of cratering the UK housing market and the economy along with it.
Markets now expect UK interest rates to breach 6% by year-end
Source: Bloomberg
The rise in interest rate expectations has supported Sterling but as the reaction to the Truss/Kwarteng budget shows that rise could be fragile
Source: Bloomberg
Having said that, the UK (or at least the bubble that I operate in) does not feel recessionary. Consumer confidence improved for the fifth consecutive month in June, buoyed by continued strength in the labour market and lower energy prices. UK May retail sales also came in better than expected, lower than last year but by less than expected, and showing small improvement over last month, which is consistent with a slowing but still relatively resilient consumer in the face of high inflation and soaring mortgage rates. Albeit these numbers pre-date the latest rise in interest rates.
So where does this leave us? While economists don’t currently forecast a recession in the UK, economic growth remains stubbornly low, inflation is stubbornly high and further interest rates that target inflation will put further pressure on economic growth. This makes the UK an unappealing place for investment right now.
One aspect of the UK that has been strong is the currency. Having hit lows in the fall-out from the Truss/Kwarteng budget last year, Sterling has strengthened. Initially supported by the return to financial credibility as Sunak/Hunt took over, more latterly this has been driven by the divergent path of UK interest rates, notably in relation to the US. In the short term the prospect of higher interest rates is usually positive for a currency, however, if economic credibility is threatened this picture can change rapidly as we saw last year. The strength in Sterling reduces somewhat the returns we receive from overseas investments (whereas last year weakness in Sterling increased overseas returns) unless we hedge that exposure. You may recall that last year we hedged a portion of our US equity exposure, which has helped protect portfolios.
Thankfully, as investors, there is a broader set of opportunities. We take a global approach to equity investing, with just a small allocation to UK equities, and so can gain access to markets with better growth prospects and where policy is more supportive. Within fixed income, the sharp rise in interest rates has provided attractive opportunities that we haven’t seen for a long time. With markets discounting further rate rises there is a chance to lock in attractive yields in short-term maturities and, due to the nature of the bond market, these are particularly attractive for higher or additional rate tax-payers.
Gareth Thomas Head of Investment Management
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All expressions of opinion reflect the judgment of Artorius at 23rd June 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
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