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High inflation is here to stay – Maddox

by: Alex Maddox, capital markets director at Kensington Mortgages
  • 05/08/2022
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High inflation is here to stay – Maddox
The Bank of England’s (BoE) Monetary Policy Committee (MPC) members voted by a majority of 8-1 to increase the borrowing rate by 50bps to 1.75 per cent, the highest increase in 27 years; with the only vote against, favouring a smaller increase of 25bps.

Inflationary pressures continue to increase month-on-month, with the price of wholesale gas the main component of the increases; fuel prices reached a record high in June. UK inflation continues to rise and was at 9.4 per cent in the 12 months to June, a 40-year high; it is expected to surpass the previous expectation of 11 per cent in Q4 and reach just over 13 per cent, with these elevated levels remaining through most of 2023.  

Ofgem have also just announced that the energy price cap will be updated quarterly, rather than every six months, which will add to inflationary pressure for many households. Looking further ahead, inflation is expected to decrease materially once energy prices stop rising, however the inflation target of two per cent is not expected to be met until 2024. 

While UK GDP growth is slowing, it still grew by 0.5 per cent in May, following a 0.2 per cent decline in April, and finished at 0.4 per cent overall in the three months to May. UK GDP is projected to remain weak in Q3 2022, with the UK expected to enter into recession from Q4 of this year. 

The latest Office for National Statistics (ONS) figures show unemployment has stabilised, remaining at 3.8 per cent in the three months to May, and employment grew by 0.9 per cent in the same timeframe. Job vacancies reached a record high in the three months to May and although we continue to see unemployment decreasing in the near term, it is expected to rise in 2023 due to slower economic growth. Regular pay (not including bonuses) increased by 4.3 per cent from March to May, however on a relative value once adjusted for inflation sat at -2.8 per cent, a record fall for regular pay. 

Overall, markets remain pessimistic about the broader macro-outlook in the UK for the remainder of the year and the outlook for 2023. 

  

   Forecast in rates 
Effective Rate  One month’s time  Three months’ time  Six months’ time  12 months’ time  Two years’ time  Three years’ time 
Bank of England Base Rate*  1.93 per cent  2.50 per cent  2.88 per cent  2.79 per cent  2.22 per cent  2.02 per cent 
Two-year fixed rate**  2.66 per cent  2.67 per cent  2.62 per cent  2.45 per cent  2.12 per cent  1.96 per cent 
Three-year fixed rate**  2.51 per cent   2.51 per cent  2.46 per cent  2.31 per cent  2.05 per cent  1.90 per cent 
Five-year fixed rate**  2.28 per cent   2.28 per cent  2.23 per cent  2.12 per cent  1.93 per cent  1.83 per cent 
10-year fixed rate**  2.04 per cent  2.03 per cent  2.02 per cent  1.97 per cent  1.89 per cent  1.87 per cent 

* Using OIS Curve [rounded to two decimal points] 

**Based on the swap curve 

  

Due to the continued rise in inflation, markets are expecting further increases in the Bank of England base rate. It is expected that there will be more tightening measures in the near term with another smaller rate hike in September and then a slightly bigger rate hike in the November meeting, after the energy price cap has been updated in October.  

However, the base rate is expected to stabilise in six months’ time and then start dropping back down in 2024. 

The two-year swap rate continues to sit above the 2.5 per cent mark with market participants anticipating it to remain steady for the next six months’ and start dropping after that when the UK is expected to be in a recession; the three-year swap rate is due to follow the same pattern. The five and 10-year swap rates are expected to remain relatively flat over the next six months, and then slowly decline after that. 

  

UK securitisation market 

Primary markets continue to be relatively quiet due to the market backdrop of rising interest rates and increased volatility. We have recently seen three transactions price from across the market, one non-conforming, one prime and one legacy deal – all continuing the current theme of pre-placing all offered tranches given the lack of liquidity and asset managers being on the side-lines.  

Banks (whether treasuries or relationship books) leading the execution of UK residential mortgage-backed securitisation (RMBS) deals continue to be a strong theme in our markets, and private/pre-placed deals are here to stay for now.  

We expect the markets to close for now as holidays mode sets in, before it re-opens in September where we know there is a fair amount of pent-up pipeline.

Currently in 2022, there has been approximately £18bn of UK RMBS paper placed into the market compared to approximately £11bn at this time in 2021 and 2020. However, this year only around £8bn of that is from new originations, the remaining being large refinancing transactions of legacy assets. 

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