Economic Overview

In April, real GDP experienced a slight uplift of 0.2% following a decline of 0.3% in March, primarily driven by increased activity in the services sector. However, the construction sector hindered GDP growth, with output falling by 0.6% due to scaled-back residential development projects in the housing and residential investment markets.

Consumer price inflation (CPI) figures for May remained at 8.7%, surprising many, including the Bank of England (BoE). Services inflation, particularly in travel, recreational, and cultural goods and services, rose to 6.3% in May, reflecting businesses passing on increased input costs to customers. Food inflation remains high due to the lasting impact of the Ukraine war on grain and cereal prices. Core inflation reached its highest rate since March 1992, at 7.1% in May.

Forecasts for CPI vary, with the OBR projecting it to be around 4.1% by the end of the 2023/24 fiscal year, dropping to approximately 0.6% by Q2 2025. The Bank of England's forecast is slightly more optimistic, anticipating a sharper decline in CPI by Q1 2024.

The Producer Price Index (PPI) peaked at 19.7% in July 2022, while the CPI reached its peak at 10.7% in November 2022. As of May 2023, the annual PPI Output (PPIo) was running at 3%, down from 5.2% in April. The decline in PPIo supports the view that the CPI is likely to begin a similar decline in line with the Bank of England's inflation forecasts. Recent falls in inflation in the United States have provided additional optimism that global inflationary pressures are cooling off.

However, the impact of global developments on the UK economy remains uncertain. Public sector pay growth figures have highlighted challenges for the Bank of England in controlling inflation. Wage inflation is an increasingly persistent challenge, with median UK pay rising at a rate of approximately 7% in May 2023. The number of economically inactive individuals due to long-term sickness is a long-term problem, exacerbated by record high NHS waiting lists.

The mortgage market dynamics are reverting to ‘normal’ pre-2008 conditions, with borrowers favouring variable rate products over fixed-rate lending. House prices have shown resilience nationally, with average growth still positive in nominal terms. Regional markets, particularly areas outside London and the Southeast, have been driving price increases. However, the market is experiencing a lack of consensus and clarity regarding the likely direction of prices in the short term, with different indices & forecasts offering conflicting results. Sales activity has remained low, and it is expected to continue below normal levels. In the absence of significant levels of negative equity, forced sales or high unemployment//falling wages (i.e. inability to service housing costs) there is minimal risk of a mortgage or housing crisis on the scale of 2008-2010.

The UK commercial real estate (CRE) sector faces its own vulnerabilities and challenges in the current economic landscape. CRE prices have experienced a decline of nearly 20% since their peak in mid-2022, primarily influenced by higher interest rates. Office and retail investments face specific structural challenges, with rising office vacancy rates and the decline of retail due to online shopping. The funding landscape for CRE investors has shifted, with a decrease in UK bank funding and a broadening of funding sources.

Assuming CPI follows the expected path back to its 2% target, the BoE will be more confident in capping base-rates sooner, lower and for a shorter duration. However challenges remain for policymakers in controlling inflation, managing wage growth, and addressing uncertainties in the housing and commercial real estate markets. The next inflation data release from the ONS on July 19th will therefore be unusually critical, with any number higher than 8% representing a major disappointment to markets and will likely to lead to a high base rate (over +6%) being set much sooner and plateauing at that level for longer.