Economic Overview
As we move into 2024 there is an air of anticipation of economic events and indicators improving as the months progress and following the tough trading conditions of 2023. Many in the real estate business and most commentators believe the market will gain momentum and transactional volumes pick up during the course of the calendar year but how quickly and when?
My view is that a rate cut of -0.25% on May 9th, 2024, is now highly likely and that that will follow hot on the heels of a surprisingly generous ‘Election Season Budget’ from the Chancellor. Combined this will lead to a significant upswing in market sentiment and reduction of finance costs going into the Summer ahead of a General Election in Q4.
The outlook for 2024 therefore seems much healthier, with sentiment on an upswing – but whether this sense of ‘relieved optimism’ will be rewarded by a year which will see both the USA and UK enter an election cycle amid the backdrop of unresolved geo-political issues in Ukraine and the Middle East, as well as Covid-enhanced Government debt mountains and relatively uninspiring GDP growth remains to be seen.
The headline Consumer Price Index (CPI) figure of 3.9% for November - a sharp decrease from October's figure of 4.6% - was the most significant surprise to the downside since early 2021 with CPI now at its lowest level since September 2021.
Five-year UK bond prices fell -4% in response and two-year gilt rates also dropped ~20bps on the previous day. As a result, expectations of rate cuts are now increasing across financial markets. Market consensus is now leaning towards two rounds of base rate cuts occurring in the first half of 2024.
December’s CPI figures compounded the surprising end to the year by then showing a 0.052% rise in inflation to 4.0% from 3.9%, when rounded to one decimal place. This marginal blip was caused mainly by significant (double digit percentage tax rise) increases in Tobacco Duty which kicked in in December. Core CPI for December remained the same as the previous month, as did Services inflation – two underlying metrics the Bank of England pays close attention to.
A factor suggesting that UK inflation may return to the 2% target sooner than expected, is the historic lagged correlation between the USA’s Harmonised Index of Consumer Prices (HICP) and the ONS CPI. The HICP, like the UK CPI, is a harmonised measure of inflation calculated similarly to the EU's HICP. It includes the rural population in America and excludes owner-occupied housing, unlike headline US inflation.
The HICP showed a mere 2.1% in November, compared to 7.1% in November 2021. Notably, the UK CPI appears to be tracking the US HICP with a lag of around 5/6 months. This can largely be attributed to earlier monetary tightening in the US and the faster pass-through of lower energy and ‘global supply chain disruption’ costs.
This suggests that the ONS CPI figures may have at least another ~0.5% to pass through in the next 2-3 months’ worth of figures, leading to a headline inflation rate closer to 3% by March.
Market participants and commentators are unsurprisingly becoming increasingly sceptical about the necessity of maintaining high interest rates in the medium term. Yet despite the growing public pressure, the Bank of England Governor's recent statements have reminded me of Gene Wilder in Willy Wonka and the Chocolate Factory where, as naughty child after naughty child runs off to their fate, Wonka’s forlorn warnings to “Stop. Don’t. Comeback!” are repeatedly disregarded. I can only hope and assume that an element of ‘political theatre’ is at play, with the members of the MPC more open to a policy shift than their voting record and public utterances of late have suggested.
Of course, the Bank can only act on the data it has available to it and follow its mandate, meaning it will necessarily adopt a conservative stance to policy. However, there is very much a sense now that the MPC are swimming against the tide - nearly all markets, commentators and consumers now seem to be ignoring the Bank of England’s statements from 2023 that rates need to remain high into the medium term, with the MPC increasingly being publicly accused of repeating their mistake from 2020 in ‘acting too late’ i.e. waiting for too much data before acting.
According to Allsop's CPI model, barring any new macro shocks, the Bank’s 2% target could potentially be achieved in the summer of 2024 based on the current trajectory. This is approximately a year earlier than the Bank of England's modal forecast from August this year predicted and would lead to a more rapid policy pivot in late Q1 or early Q2 than is being anticipated.
We believe the trading environment is slowly picking up and I have pleasure in introducing our current market thoughts and observations from across our respective teams. If I or any of my colleagues can help then please do not hesitate to ask.