The Good, the Bad and the Economy...

June was a challenging month for the UK economy, marked by concerning core inflation numbers and unexpected actions by the Bank of England. Despite expectations of a 0.25% increase, the bank raised interest rates by 0.5% to 5.0%. This decision triggered a mini panic in the mortgage market and drew criticism towards Andrew Bailey, the Bank's Governor. However, Bailey had been buying time as UK inflation was predicted to decrease significantly, but not until August when the 15% reduction in electricity and gas prices would impact inflation figures. It's worth noting that historically, UK interest rates tend to be slightly higher than their US counterparts.

The UK's deviation from historical interest rate patterns necessitated action to bridge the gap. During a European Central Bank symposium, Bailey outlined the technical challenges faced by the UK and other central banks in managing inflation. The labour market emerged as the UK's major concern, as the available workforce remained below pre-Covid levels, unlike in other major economies where labor shortages were less severe.

Feedback from the Bank of England's network of agents indicated that companies were unlikely to lay off employees during a recession, rendering the main tool for curbing inflation less effective. These agents also reported that food manufacturers were locked into expensive supply agreements resulting from the Ukrainian invasion, but these agreements were set to expire soon, potentially flattening food price inflation. Typically, food price inflation decreases only when a supermarket starts a price war.

Globally, inflationary pressures were subsiding, with significant decreases in prices of commodities like Copper, Oil, and Wheat, which were 30% to 50% lower than levels during the Ukrainian invasion. A return to a more normal situation was expected, although not immediately.

In May 2023, the UK experienced a core inflation rate of 7.1%, the highest since March 1992 and exceeding market expectations. This increase was driven by discretionary purchases such as theatre and concert tickets, flight tickets (likely influenced by additional bank holidays), and computer games (attributed to the release of The Legend of Zelda). While these purchases might reverse in June, the Bank of England needed to demonstrate action and therefore reduced the gap between UK and US interest rates.

The question arises as to why the UK and the US have not entered a recession while Germany has. The answer lies partly in the UK's higher household savings compared to the US and major European countries. This trend is partially explained by the UK's aging demographic profile and greater home ownership, leading to comparatively wealthier retirements for UK citizens. Unlike the US, the UK has not reached a stage where savings are being depleted, even amidst the "cost of living crisis."

The UK mortgage market also plays a significant role. Decreasing interest rates have resulted in a decline in outstanding mortgages, potentially influenced by the aging UK population. Additionally, the proportion of mortgages on floating rates has decreased significantly, with more households opting for fixed-term mortgage products. Consequently, only about 10% of households are expected to be impacted by interest rate increases by the end of 2024. This poses a challenge for the Bank of England since food manufacturers cannot reduce prices, employers are unlikely to lay off staff, and most mortgage holders are unaffected for the time being.

Given these circumstances, Bank of England Governor Andrew Bailey must wait for external factors, such as energy prices, to decrease and hope for imported deflation to alleviate the current inflationary pressures.

#Cognisant are a senior level search firm operating within the residential development, mixed-use and wider property sectors. www.cognisantsearch.com