Inflation Hits 9.1%
In June, UK inflation reached a 40-year high of 9.1%, creating consternation in an economy that had, until recently, enjoyed decades of relatively stable prices, moderate wage growth and low interest rates. Furthermore, an economy which appeared to have weathered the worst of Covid remains relatively unscathed.
The economic outlook changed rapidly in the first half of 2022. The year began with a boost to confidence as the Omicron variant turned out to be less severe than Delta and quite quickly people returned to public transport, shops and the office.
By February the invasion of Ukraine hit headlines and the full impact of the cost-of-living crisis began to emerge. Latest economic forecasts significantly differ from those issued only a few months ago. In June, the Bank of England suggested that inflation would peak at just over 10% later in 2022, more than double the consensus forecast of 4.6% for the year back in February.
GDP expectations for 2022 have fallen from 4.3% at the beginning of the year to a current consensus forecast of 3.8%, with economic growth expected to slow further next year (the current consensus is for 1.0%). The Bank of England have a more pessimistic outlook for economic growth next year, suggesting that the GDP growth rate could fall slightly (-0.2% in 2023). More downward revisions to GDP growth forecasts seem likely in this uncertain environment.
By far the highest profile event over the last 6 months, the invasion of Ukraine, unfortunately now looks set to be a lengthy conflict. Focusing on the economic impact, war in itself is a source of uncertainty, but as long as it doesn’t spread through Europe then the most likely economic impact will be through supply chain constraints and inflationary pressures, particularly sharply rising energy costs.
There is a significant ongoing energy risk, given the reliance of many EU countries on Russian supplies, most notably Germany which imports around 50% of its natural gas from Russia. Germany is looking at alternative sources (probably the Middle East) but in the meantime energy prices are likely to remain volatile.
The UK imports roughly half of its natural gas, with the lion share of that coming from Norway. Only a small proportion comes from Russia (less than 5%) but clearly that hasn’t left us immune to energy price fluctuations.
Energy price rises is one of the key factors that has brought the cost-of-living crisis to the fore. Real household disposable income is held as the best measure of household wealth over time, adjusting for changes in cost-of-living such as taxation, benefits and inflation. The most serious declines in this measure were in 2011 (-3.5%) and in the mid-1990s (-3.8%). The current forecast for 2022 is -2.3% with broadly flat expectations for 2023 (-0.1%).
In recognition of the hardships facing many households this year, the Chancellor stepped in with alleviation measures in May – announcing £15bn in support to help with rising energy costs. The emerging consensus is that these measures, which are more significant for less wealthy households, could be enough to stave off a recession next year. It remains to be seen whether they will be enough to bolster consumer confidence which had sunk, in May, to its lowest on record.
The residential sales market is largely driven by what people can borrow and at what cost. With inflation running high, the Bank of England increased base rates to 1.25% in June, with a further 50bp rise expected before the end of 2022. The typical margin between mortgage rates and the bank rate (typically 1.5 percentage points over the last year) suggests the average new lending mortgage rates will be around 3.4% by the end of 2023, the highest rates in almost 10 years.
There is a risk that the Bank of England feels it necessary to raise interest rates further in the face of cost and wage inflation. Rates rising higher than currently expectations would present a shock to the housing market that over recent years has acclimatised to low rates.
The vast majority of new mortgage borrowers are on fixed rates (representing 92% of new loans over the last 5 years) offering protection, at least until the fixed term expires. However, it will be increasingly hard for first-time buyers to make it onto the property ladder in London. Saving for deposits is a key hurdle, particularly when other household bills are rising. As an offset for now, the jobs market is remarkably strong and earnings have been increasing.
Any fall in the number of first-time buyers (FTB) does have an impact on the rest of the housing market eco-system, in an absence of FTB, it is more difficult for second steppers and so on. Furthermore help-to-buy is being phased out by 2023, which has helped many FTB onto the housing ladder. Whilst current interest rate increases are forecast to be modest, this does drive affordability in the wrong direction.
Testimony to the strength of the market across the UK is stamp duty land tax receipts that amounted to approximately £14.1 billion in 2021/22, compared with £11.61 billion pre pandemic in 2019/20. The total was boosted by the 2% surcharge on the purchase of residential properties by overseas non-residents which was introduced on 1 April 2021. From introduction up to the end of Q1 2022, this surcharge had been levied on 10,400 transactions, collecting £111 million.
London is busy once more: passenger numbers from Transport for London show that across all their types of transport they are back to between 73% and 98% of their pre Covid levels. Likewise, the Pret Index, which tracks the activity across a range of its London store locations, shows a strong recovery in sales which are now above pre-pandemic levels in the West End, at London stations, in London suburbs and at airports, with particularly strong sales at airport locations. For the city and Canary Wharf, sales are back to 87% of pre Covid levels reflecting current hybrid working practices of more days worked from home.
London is also enjoying the return of international travellers, the absence of which was keenly felt through Covid. Data on passenger numbers for Heathrow show that in April the number of passengers was back to 5.1million with prior Covid passenger numbers around 6 million per month, which like the TfL passenger numbers, is back to 75% of prior levels (hoping that logistical problems with airlines doesn’t detract from this bounce back).