JPMorgan has warned of a major risk the Bank of England may have to raise interest rates as high as seven percent to deal with inflation, and trigger a "hard landing" to sort out Britain's economy.
Economist Allan Monks wrote a note to clients that a hard landing - a marked economic slowdown or sharp downturn - "looks increasingly likely".
Mr Monks also suggests some metrics suggest the Bank's base rate will have to rise a further two percentage points from its current five percent to bring inflation under control. Fears of an impending recession will not be alleviated by today's report from the financial giant.
Mr Monks noted "lots of caveats" in his report, and that his central forecast is a more moderate peak of 5.75% in November. 5.75% interest rates would match the highest rate experienced during the 2007 financial crash, and were only surpassed in February 2000. Mr Monks' high prediction of 7% would be the highest interest rates experienced in Britain since October 1998.
Last week at the Liaison Select Committee, Rishi Sunak warned interest rate rises were struggling to feed through into immediate inflation reductions because of the prevalence of fixed rate mortgages, meaning many homeowners are yet to feel the effect of rate rises. JPMorgan's analysis also found that "higher than normal wage growth" is offsetting some of the blow of more expensive mortgages despite the 18-months-worth of successive hikes.
Britain is now the only G7 country where inflation is still rising, according to a report in The Times. It is also one of the three worst countries within the 38-strong OECD group of countries.
Inflation increased from 7.8% in April to 7.9% in May, compared with an average reduction in inflation from 5.4% to 4.6% in the G7. The analysis also uses a lower measure of inflation than the official Bank of England calculation, which says CPI is running at 8.7% unchanged from April.
The Bank of England has a target set by the Government of keeping inflation to below two percent, something it has failed to achieve despite 13 consecutive base rate rises. Rishi Sunak is facing political pressure over the issue, as well as economic pressure.
The Prime Minister promised to hold inflation from the then-10.7 percent rate as one of his five targets for the year. While the aim was mocked when first set as something No 10 would easily achieve without much difficulty, the problem of so-called 'sticky inflation' has cast doubt over whether the Prime Minister will achieve his halving aim within the promised timetable.
Azad Zangana, senior European economist and strategist for Schroders, said "while the asset manager had previously thought the Bank of England would refrain from aggressive interest rate hikes, the environment has changed and so has his view. Higher than expected inflation and the latest interest rate rise suggest the Bank of England is far from getting on top of bringing the cost of living measure down. Schroders now anticipates interest rates to peak at 6.5% by the end of 2023, a full 1.5% points higher than its previous forecast of 5%. Schroders is predicting that rates will rise by 50 basis points (bps) in August and September, before slowing to 25 bps increments in November and December. Unfortunately, the Bank of England is no longer able to wait and see how the interest rate rises so far will affect the economy. We also cannot rule out that the path the bank seems now to find itself on, with the potential to disproportionately impact the housing market, will not result in financial stability issues. Interest rates work with long and variable lags, and it is not exactly clear yet what the effect of the 13 consecutive rate rises seen so far will be. The financial markets have already begun to consider rates peaking at 6.5%, with mortgage pricing rising. Last months interest rate rise confirmed that the Bank of England lacks the credibility to adopt a wait and see approach as being taken by the US Federal Reserve, which paused rate hikes this month. This suggests that the MPC will no longer target a level of rates, but instead focus on the rate of change in rates. It also suggests it will respond to data as it comes in, not too dissimilar to the approach of the European Central Bank.
Rising rates always affect the housing market with a lag, but this time around there are a number of reasons why the lags will be even longer and more variable than in the past. Notably, UK households have taken advantage of very low interest rates and increased fixed-term mortgage products to reduce their near-term exposure. The share of households with a fixed-rate mortgage of two years or more has risen from 16% to 63% between 2012 and December 2022. The Bank of England is under attack from those suggesting that interest rates should not be raised at all if they’ve not worked so far in lowering inflation. However, the chancellor has publicly backed further hikes in recent days, while the prime minister said at the weekend that taming inflation through higher interest rates should be the key priority. We agree, but unfortunately taming inflation is probably now going to involve inflicting more pain than it might otherwise have done."
Why aren’t soaring interest rates bringing down inflation?
PM pins blame for stubborn inflation on fixed-rate mortgages, but economists say the picture is more nuanced Rishi Sunak has blamed the high number of fixed-rate mortgages for his government’s failure to bring down inflation. Speaking to the Commons liaison committee, the prime minister claimed that the preponderance of homeowners on multi-year deals was the reason why inflation has been “proving more persistent” than anticipated.
But experts don’t all agree with the PM. Many argue that the UK’s stubborn inflation is due to a combination of factors, many global rather than national, which have been exacerbated by the fact that many economists and central bankers “were late to spot just how big a problem this wave of inflation would prove,” the Financial Times (FT) said.
Critics immediately responded that the prime minister’s comments were not only false, but “tin-eared” in their lack of sympathy for struggling mortgage holders.
Sarah Olney, the Liberal Democrats’ Treasury spokesperson said “homeowners on the brink are facing yet more mortgage misery, while Rishi Sunak’s comments get more tin-eared by the day. It shows this Conservative government is just totally out of touch. Conservative ministers sent mortgages spiralling through all their chaos and incompetence. Now they are refusing to lift a finger to help."
What did the papers say?
The reason for inflation’s persistence in the face of aggressive rate rises is down to a “tight labour market, shifting housing market trends and the fragility of the global economy”, said the FT, but it is important to remember that monetary policy “always comes with a lag”, taking around a year and a half for the impact of a single rate increase to “fully seep through into spending patterns and prices”.
Monetary policymakers only began raising rates under a year and a half ago in the US and UK, and under a year ago in the eurozone, the paper said, so it is not surprising that we have yet to see much impact. Regardless, the UK remains an outlier, said City AM. Britain is now the only rich country where inflation is rising, signalling that the Bank of England’s series of interest rate rises “have been less effective than its peers”, the paper said, citing new data out last week.
According to the Organisation for Economic Co-operation and Development (OECD), inflation across G7 nations fell to 4.6% in May, down from 5.4% in April. In the UK, meanwhile, inflation rose to 7.9% in May from 7.8%. While it is true that most of the world experienced economic fallout from Covid-19 and the war in Ukraine, in the UK “this has been exacerbated by Brexit and 13 years of government austerity measures”, said Open Access Government.
As a result, the scale of the crisis here in Britain is “far worse when compared to most of the OECD countries”, the site said, “and certainly among those in the group of G-7”.
Additionally, there is the prospect of greedflation as “banks, oil companies and many companies in food supply chains are very clearly increasing their absolute levels of profit, and their profit rates,” as interest rates increase, tweeted political economist Richard Murphy.
Murphy’s assessment is that increasing interest rates is in fact an inflationary act with the Bank of England’s assessment appearing to be “based on what economics textbooks say, and the relationship between economics textbooks and reality ceased a long time ago”. Murphy added that a recession now seems to be inevitable as the Bank “has always wanted a recession to control inflation”.
What next?
Numerous economists agree with the prime minister’s suggestion that the effects of the Bank of England’s rate increases are taking longer to feed through to the economy due to the prevalence of homeowners on fixed mortgages rather than floating contracts.
Those who do say we may see inflation turn a corner soon, City AM said, because at the start of 2024 millions of mortgage owners are set to roll on to new deals with much higher rates, which could help bring down inflation by “eroding their spending power."
There is a further risk that the longer lags from the rate rises,the more the Bank of England is at risk of being “egged on by the markets into raising rates in response to figures that are disappointing”, which could result in “overkill and further damaging the economy, perhaps very seriously”, said David Smith, the economics editor of The Sunday Times.
But the broader problem, not just in Britain but around the world, may simply be that central bankers raised rates too late, said the FT. Their initial insistence that inflation would prove short-lived led to delays which “may have made inflation all the more difficult to vanquish."
The risk now is that high inflation becomes the norm, according to the Bank for International Settlements (BIS). Claudio Borio, the head of BIS’s monetary and economics unit, warned last year that he was concerned that “inflationary psychology” was setting in.
Jennifer McKeown, chief global economist at Capital Economics said."with inflation remaining stubborn, the future looks bleak, and the ultimate effect will be that higher rates “push most advanced economies into recession in the months ahead."
Higher interest rates are already hitting prime regional markets - research
Higher interest rates have already softened UK prime regional markets but cities are proving resilient, Savills claims.
Research by the agent shows average prime values across UK markets outside of London – broadly the top 5% to 10% of the market by value – slipped by 1.5% in the second quarter, leaving them -3.5% down annually, yet still 12.1% up since the first lockdown in March 2020.
In contrast to a prominent pandemic trend, city markets are proving more resilient than their more rural neighbours, Savills said.
Over the past year, high value housing markets in key regional cities saw price falls of just1.4%, while village and rural house prices fell by 3.7% and 3.9% respectively. The impact of the work-life balance reset has been most keenly felt in the suburban and commuter markets – typically home to families and highly leveraged upsizers – where buyers have increasingly prioritised proximity to stations with direct links into London, Savills said.
The inner commuter belt, within a 30 minute train journey of London, has experienced the most significant price falls over the past year, with a 5.2% average decline. In contrast, prime markets furthest from London including the Midlands an North of England, Scotland and Wales, where mortgage affordability is least stretched, have outperformed with less downward pressure on prices.
Across the UK’s prime regional markets, while down on last year, new buyer registrations are currently standing up well to pre-pandemic levels, Savills said.
In June, they remained 17% above June 2019, and while supply constraints have eased, stock levels are still 5% down, Savills reports. Frances McDonald, director in Savills residential research team, said “with increasing pressure on buyers’ budgets, committed sellers need to price in a way that reflects the prevailing macroeconomic conditions to achieve a sale. But the work-life balance has had something of a reset over the past six months, which has helped underpin values in prime city locations across the country which are now marginally outperforming. Ease of access to transport, work and amenities are once again priorities that trump lifestyle considerations for some buyers."