Interest Rates Rise to 5%
Latest forecasts suggest the economy will grow by a modest 0.3% in 2023, certainly impressive compared to economic forecasts which at the start of the year expected a recession. Unfortunately, though the resilience of the economy is part of the problem, with the Bank of England desperately trying to curb demand and therefore inflation. The more protracted the inflationary period becomes the more likely the Bank of England has to take more significant action to suppress demand. So, a recession is not yet off the cards.
Fresh concerns have arisen over the inflation numbers. For much of the last year the concern has centred on the headline rate of inflation. This finally started to fall back in the April 2023 data, predominately as wholesale energy prices eased and have started to flow through to consumer prices (albeit slowly). Although the headline rate eased, core inflation increased. Core inflation strips out the more volatile components of food and energy prices. This is concerning as it shows that inflation might have become more domestically entrenched.
The reaction to the April inflation numbers (released on 24th May) was immediately felt in the interest rate markets. The 5-year swap which had settled around 4% post the Liz Truss growth plan reacted by rising to 4.75%-5%. This reflected the fact that interest rates were likely to have to go higher. And indeed, the Bank of England did just that, raising rates by 50 basis points to 5%. Uncertainty in the mortgage market led to several mortgage lenders pulling mortgage products as they re-evaluated the new interest rate outlook and the rate at which they wanted to underwrite new business. The market feels very much like it is hanging on every piece of economic data released and inflation remains the most watched indicator.
For the UK wide residential market, prices have stabilised somewhat over the last few months but this might be a false dawn, as the market digests the latest interest rate flux. Mortgage approvals are certainly already low: 26% below their 10 year average pre-Covid but still a margin above the worst year in the financial crisis. As and when the path of interest rate becomes clearer, these low mortgage approval levels should lift.
Employment has been a key factor in the resilience of the economy. In prior economic downturns employment typically has fallen. In the Global Financial Crisis, London lost 4% of its service sector jobs. Through Covid London lost 4% of service jobs and total jobs declined by 5%. Since Covid, London service sector jobs have bounced back and grown +9% beyond pre-Covid levels. The strongest growth beyond pre-Covid levels has been for ‘Financial and Insurance Services’ which is 21% above pre-Covid levels.
Some sectors have only just recovered their Covid-losses, for instance ‘Accommodation and Food service activities’ fell 18% through Covid and remains -2% below pre-Covid levels. Construction fell 24% through Covid and remains -6% below.