Markets Weekly podcast – 13 February 2023

Henk Potts (HP): Hello there. It’s Monday, 13th February and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets. 

My name is Henk Potts, Market Strategist with Barclays Private Bank, and each week I’ll be joined by guests to discuss both risks and opportunities for investors. 

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We will then consider the outlook for the UK property market. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead. 

The impressive rally in equity markets ran out of steam last week as mixed corporate earnings and concerns that the Fed will have to deliver a higher peak rate to tame inflation overpowered improving economic data out of China and the pickup in US consumer sentiment.

In fact, US stocks and bonds registered their worst week of the year. The S&P 500 fell 1.1%, its biggest weekly decline since the week commencing 11th December, but is still 17.2% above its low on 13th October last year.

Treasury yields posted their biggest gain in a month last week. Ten-year yields declined to 3.75% as traders bet that the Fed funds rate will peak above 5% and reduce the probability of a rate cut during the course of this year.

In Europe, the STOXX 600 fell six tenths of 1% over the course of the week. The index is 20.6% above its October low. There were some notable movements in commodity markets last week. In fact, oil rallied 8%, crude’s biggest weekly gain in four months as markets reacted to the threat from Russia to cut output by 5% in March in response to the imposition of price caps by the West.

On the macro front, expectations going into the UK’s fourth quarter GDP reading on Friday were pretty bleak, but the UK economy, it has to be said by the thinnest of margins, managed to avoid falling into a technical recession, i.e. two consecutive quarters of contraction in the second half of last year. 

Activity stagnated in Q4 following the two tenths of 1% decline in Q3. That’s where the good news stops because the data revealed that output in December shrunk by half of 1%, which is below consensus with the weakness very much being driven by the services sector.

The UK economy is still 0.8% smaller than its size at the end of 2019, making the UK the only Group of Seven country that is yet to fully recover output lost during the course of the pandemic. The loss in momentum at the very end of last year highlights the impact of that cost of living crisis playing out, resulting in softer household consumption, high levels of industrial action by public sector workers, and reduced levels of investment.

In terms of the economic outlook for the UK, well, we look for a shallower and shorter recession than previously feared, but the UK economy is still expected to contract by six tenths of 1% during the course of this calendar year, followed by a very sluggish recovery in 2024 with growth of just 0.3% as the impact of higher interest rates, elevated levels of inflation and the rising tax burden all weigh on the UK’s growth prospects.

Given that weak economic outlook, and the dovish tone from the February Monetary Policy Committee meeting, we still expect the Bank of England will hike rates, but we only see one more increase of 25 basis points coming through at the March meeting, setting the terminal rate of 4.25% for UK base rates after which we’d expect the policy rate to be on hold until the first half of 2024.

In terms of Europe, well, economic data is actually proved to be more resilient than expected over the course of the past few months helped by that lower-than-expected impact from energy supply concerns. However, household demand is starting to weaken. In fact, retail sales fell 2.8% in December year on year. Eurozone consumer demand is expected to remain constrained during the course of this year due to persistent and elevated levels of inflation. We expect eurozone CPI to average 5% during the course of 2023. 

The labour market in the eurozone looks less resilient than elsewhere. In fact, we’ve got unemployment rising to around 7% at the end of this year. We also think that consumers are nervous about the economic outlook, so we think there’ll be decreased willingness to dip into their excess savings built up during the course of the pandemic, all of which will weigh on eurozone growth prospects during the course of 2023.

So, that was the global economy and financial markets last week. In order to discuss the state of the UK property market, I’m pleased to be joined by Stephen Moroukian, Head of Product and Proposition, Real Estate Financing for Barclays Private Bank.

Stephen, great to have you with us today. Former Prime Minister Liz Truss’s administration’s mini budget, as we know, sent a shockwave through the UK mortgage market. So my first question is, have conditions calmed down over the course of the past few months given the fact that we’ve got a new government? And secondly, what are your predictions for property prices, and do you see a difference between London and the rest of the UK property market?

Stephen Moroukian (SM): Good morning, Henk, and great to be on today. In terms of UK property prices, it’s a tale of two markets, London and the rest of the UK. If we look at the broader UK market, we have commentators still predicting an 8% to 15% fall in values over the next 12 months. And if we look at the UK HHPI figures for the last six months the index has fallen just under 4.5%. 

And don’t forget this is the market which, broadly, has seen a once-in-a-generation uplift in value over the last four years. And, to put context around that for our listeners, that’s an average property price in the UK today of £281,000, which peaked at around £294,000 in August last year. So, we’re back to the levels recorded at around March last year, and that’s still up 10% to 15% over five years.

Now, the January window is one that, typically, signals the start of the spring property market as buyers and sellers begin to register their interest, they test the market, and what must be remembered is that this market is inextricably linked to the health of the mortgage market, so it will be this data that all the commentators are agonising over right now. And one thing I can assure you is months of column inches in the press, which will be devoted to those anecdotal stories of folks trying to sell, trying to buy, through the new conundrums they face in this market.

So, the question to answer between now and April is, have we seen the worst of this as sentiment and broader economic data starts to look more positive, or is there a longer tail to play through?

The London market and, indeed, the prime central London market is behaving very differently. As a reminder this is the market which since 2014 has navigated through some incredibly tough headwinds, whether that be tax changes, legal tightening, pre-imposed Brexit uncertainty and then, of course, the pandemic effectively closing London. The story here is one of much milder price impact. In fact, negative 3% to 5% this year, and there’s a number of reasons for that. 

Firstly, there isn’t that same high dependency link with the mortgage market. Secondly, there’s a continued shortage of stock for what’s called best-in-class property, and you’ll have heard me mention that one before a few times. And lastly, the reopening of London, both to the UK and international buyers, has coupled at a time when we’re seeing favourable sterling/dollar exchange for foreign buyers, which means we’ve got a lot more motivated buyers and sellers ready to deal.

And, certainly, in terms of the people I talk to who are in the market, you know, they’re telling me there’s high demand at the moment for those properties above £10 million and in those prime locations, so the data suggests as busy as ever in terms of applicant registry, viewing and transaction levels at that part of the market.

HP: Stephen, over the course of the past couple of months, we know there have been some big headlines regarding a mortgage price war playing out. So, what’s been happening with rates?

SM: Well, great question, Henk. The first point to note is that mortgage approvals are really down at around 35,000 approvals in December. And just to, again, put that into some context for the listeners, at the height of the pandemic approvals fell to around 10,000 approvals per month. And at their peak, remember, the stamp duty holiday and the race for space foray, approvals went up to nearly 110,000 a month, and the last three-year average was around 70,000. 

So, that gives you a sense of where we are and sets the scene. We’re in a real low right now, but the sentiment is that the market opens up and that rates begin to settle, we will begin to see a surge upwards again. But that’s the number that everybody will be watching between now and April.

In terms of fixed rates, these peaked at 6% to 7%. They’re now comfortably falling and widely reported at currently just under 4% for a five-year fixed rate, which is still a good 2% above their lows two years ago but, without a doubt, that feels like definite calming and easing for those that are refinancing shortly.

Tracker rates, well, they’ve gained new popularity as borrower sentiment has shifted to the perception of a lower interest environment in the future and the expectation that the Bank of England base rate will fall over the two-to-five-year horizon. What’s very interesting is that with the latest Bank of England base rate rise we’ve seen, we’re now seeing the mass market tracker rates and fixed rates become much closer to each other in overall cost despite the big UK lenders, indeed, engaged in a price war as they jostle for market share in a much lower transaction environment. 

And in terms of the price war, many of the high street banks, you know, they’re awash with liquidity right now and mortgages represent really the only scale way of using that liquidity up. So, the transaction flow is tighter, price elasticity is key.

HP: Well, thank you for sharing your thoughts around rates and the settling down that we’ve seen in terms of the markets and buyer demand starting to shine through. The other interesting aspect, as we know, is that many investors, including international ones, have been keen to have exposure to the UK property market. So, how have investors reacted to the changes that we’ve been seeing in terms of market conditions?

SM: Well, it’s really interesting one, Henk. This one has got us all talking at the moment. Buyers have spoken with their feet. The Q4 data for purchases that are subject to higher stamp duty rates, so that’s buy-to-let and second homes, they’re all down around 17%, and that’s likely a trend that will continue. And, without a doubt, residential rental values are up, and in some cases dramatically. 

However, you have to think about that with the counterbalance of higher funding costs, and that’s in higher interest rates, higher management fees, that’s got an inflationary impact, less tax breaks and the spectre of possible rent control or other government intervention like we’ve seen in Scotland. The maths makes it less appealing unless one is benefiting from either a currency play or a heavy discount. 

So, I think it takes a really steady hand right now to enter this market and, hence, we’re seeing greater international buyer interest who are seeing emerging value and I believe there’s a lot of cash ready to deploy, but, of course, that itself is propping up the good value assets that are out there and making them even higher demand. So, it’s a bit of a cyclical moment, Henk.

HP: Finally, Stephen, how are buyers and investors interpreting the political outlook, and what implications could changes in policy have for the UK property market?

SM: Well, it’s definitely on clients’ minds. You know, we certainly find as we race towards an uncertain general election outcome, sentiment may shift to a hold and wait. It’s definitely too early to see any evidence of that at the moment and, as I’ve already highlighted, properties about £10 million in Greater London the last two quarters were incredibly strong and that’s against the backdrop of not only the mini budget, but also increased regulation around transparency rules when holding properties in non-personal entities. So, short and longer-term considerations aren’t holding buyers back right now.

HP: Well, thank you, Stephen, for joining us for this podcast. I travel around the world, spending time with clients and they’re always interested in the outlook for the UK property market so thank you, once again, for sharing your insights today.

Let’s move on to the week ahead where the focus will be on the January inflation reports for the US tomorrow and the UK on Wednesday.

In the US, we forecast that prices rose half of 1% month on month, 6.2% year on year, which would represent the lowest reading since October 2021 at the annual rate. Price pressures are still being driven by an increase in energy prices. Average retail gasoline prices in the United States rose 4.4% in January, and ongoing food inflation, which is still running at just under 10% year on year.

Core CPI is expected to rise 5.5% year on year, supported by services inflation, specifically the shelter component. Deflation in core goods is expected to have paused as used car prices stabilise.

The moderating trend in price pressures is expected to continue over the medium term in the US but may take a little bit longer to resolve than previously forecast, with US CPI now forecast to be at 2.6% at the end of this year, and 2.3% at the end of December 2024.

Given the slightly slower moderation in terms of inflation expectations and the ongoing strength that we see in terms of labour markets, we expect a higher peak rate for Fed funds. We now think the US central bank will add an additional 25 basis point increase in June. Therefore, we project the terminal rate for this hiking cycle will be 5.25% to 5.5%. 

We think that the policy rate will then be on hold for much of the year but then, as inflation moderates, as growth falters, labour markets cool towards the end of the year, we do see the potential for the Fed to pivot to an easing stance with a 25 basis point cut pencilled in for December, followed by six rate cuts during the course of next year, suggesting the target range for Fed funds at the end of 2024 will be 3.5% to 3.75%. 

Finishing off with the UK, where we expect January headline CPI to print at minus 0.1% month on month, but still in double digits in terms of that annual rate at 10.5%, and core CPI to print at 6.3% year on year.

In terms of the breakdown, we forecast that food, alcohol and tobacco will provide an upward contribution. Energy is likely to have exerted downward pressure, however. Household bills, remember, are capped. Petrol prices fell in January in the UK. At the core level, we expect goods to provide another negative contribution due to the falling commodity prices and improving supply chain. We look for a slight uptick in services inflation supported by a tight labour market and wage growth.

We expect UK inflation to moderate at a slower pace than elsewhere during the course of this year due to the ongoing disruption for the supply of labour and goods as a result of Brexit and, of course, the pandemic. We forecast UK CPI, for example, will average 7.3% during the course of 2023.

And with that, I’d like to thank you once again for joining us. I hope that you’ve found this update interesting. We will, of course, be back next week with our next instalment. But, for now, may I wish you every success in the trading week ahead.