Taking five charts of key indicators, Robert Plant, Portfolio Manager, Multi-Asset Solutions, analyses how they inform us about the future path of interest rates and the likely length and severity of impending recession.
After a tumultuous few months for UK politics, that led to the resignation of Prime Minister Liz Truss, there are signs that markets have stabilised. The prospect of significant government borrowing to fund the largest (unfunded) programme of tax cuts in decades created significant volatility, as well as serious concerns around the sustainability of government borrowing going forward. Yields rose sharply and UK credit default swap rates (a measure that reflects the credit risk of the UK government) spiked higher – a sign that markets were unwilling to absorb a large increase in gilt supply on the prevailing terms.
Credit Default Swap Rates
Source: Bloomberg and Columbia Threadneedle as at 29 Nov 2022.
Peak UK base rate revised lower
The terminal rate (the level at which a central bank stops raising interest rates) in the UK was expected to rise beyond that of the US, peaking at 6.5%. Since the u-turn, however, expectations have been revised to 4.6% (below the expected terminal rate for the US).
Fiscal tightening and recession in 2023 should supress demand-pull inflationary pressures sufficiently to allow the Bank of England to end its hiking cycle sooner than previously expected.
Terminal Interest Rates
Source: Bloomberg, as at 29 Nov 2022
There are few developed countries which have felt this as acutely as the UK, with consumer prices rising 11.1% year-on-year in October. Unlike the US, inflation in Europe and the UK has been driven primarily by higher gas and food prices – a direct consequence of the war in Ukraine and the continent’s dependence on Russian gas.
UK alone with GDP still below pre-Covid levels
% change in Real GDP from Q4 2019 level
Source: Bloomberg and Columbia Threadneedle, as at 29 Nov 2022.
Housing market’s processing of policy events continues
Source: Macrobond and Columbia Threadneedle, as at 29 Nov 2022.
While bond yields have fallen from the September highs, mortgage rates haven’t fallen as much with banks increasing spreads, due to the elevated risk of lending. The fall in mortgage rates should gather pace over the coming months as markets’ expectations for the UK base rate continue to moderate.
RICS price balance (% surveyors reporting increases vs. decreases)
Source: Bloomberg, as at 29 Nov 2022.
The backdrop for risk-assets will continue to be challenging
Looking forward, the path of future interest rate hikes and the length and severity of recession, will be extremely consequential for UK markets. Policymakers will want to be certain that inflationary pressures have indeed rescinded before easing policy and, therefore, we expect the backdrop for risk-assets will continue to be challenging. The UK faces particular problems with a wide current account deficit, high sensitivity to interest rates and the prospect of fiscal austerity. We expect a protracted if mild recession in the UK.
