The squeeze

Given Labour’s ambitions to spend more on public services, but with untrammelled borrowing out of the question ever since Liz Truss’s dalliance with bond markets, higher taxes are inevitable.

However, new Chancellor of the Exchequer Rachel Reeves has not given much away about how much she’ll take – the manifesto mentions ‘only’ £7–8 billion or so of estimated revenues, mainly from closing loopholes on non-doms and imposing VAT on private school fees. While a staggering sum in its own right, it nonetheless pales in comparison to the overall tax haul and will certainly not be enough to move many of Labour’s preferred dials.

We can therefore surmise that further hikes lie down the line. Some have speculated that capital gains tax could be increased, perhaps in the autumn. If so, it would plausibly happen overnight, minimising any warning to crystallise profits at a lower rate. Other rumours include the possibility of closing loopholes relating to agricultural land and inheritance tax.

On this particular front, we think it generally unwise to take pre-emptive action which could prove a mis-step. It rarely pays off to boldly rearrange your assets on the basis of what others might decide. Broader conversations centred around your financial goals are usually the best way forward.

Besides, it may well be the case that the young government opts to prove its fiscal discipline. Waiting a year or so might buy it headroom for spending in a future budget, especially if international borrowers conclude that the UK really is one of the world’s safest havens for the time being.

Counting the uncountable

But whatever ‘dullness dividend’ accrues to British assets, it will ultimately have to be weighed against the cumulative effects of Labour policies over the coming years.

In this respect, Angela Merkel’s Germany serves as a warning – her decade-plus as Chancellor was hailed as a model of sensible Teutonic order. But no sooner had she stepped down than the bill of her anti-nuclear energy policy came due – in rubles.

We cannot know in advance whether Labour’s clean energy ambitions or indeed any other of their manifesto pledges will be successful or self-sabotaging, but they will undoubtedly have an effect. The point is that although the short-term political outcome is clear, long-term uncertainty remains.

Indeed, supply-side reforms may represent the juiciest low-hanging fruit for Labour to pluck. Development of nuclear power plants, prisons, film studios, department stores and of course houses have all been blocked over the past 20 years or so. Giving the green light costs nothing to the Treasury and may well spur increases in productivity.

But Labour’s interventionist instinct is all too visible in a battery of new regulations to be foisted on businesses. With costs not easily quantified, such measures are typically subject to less analysis than those with numbers attached (whether plausible or not), yet their long-term effects could be substantial.

And that is before we even consider what lies downstream of cultural policies. After all, the Enlightenment was never in any manifesto, but measures to set it back have featured in many.

Looking rosy?

Back in 2010, the Conservative–Lib Dem coalition made the most of a note left in the Treasury apologising for there being ‘no money left’. Now, a fresh intake of Labour spin doctors is putting out a twist on that blame game, insisting that they’re the victims of an economic hospital pass. Is that fair?

It’s true that interest rates are relatively high and public debt is a chastening 100% of GDP, but the picture is not unremittingly bleak. UK growth has recently been the highest of all G7 nations, inflation is down to its 2% target, and manufacturing activity is expanding, in stark contrast to sharp industrial declines in France, Italy and Germany.

Looking ahead, Capital Economics forecasts GDP growth of 1.2% in 2024 and 1.5% in both 2025 and 2026, above the consensus view. This is in part due to the anticipated productivity benefits of artificial intelligence.

All in all, it may well be that both Emmanuel Macron and Rishi Sunak rue their summer snap elections, albeit for different reasons.

Debt timebomb?

We can be reassured that Rachel Reeves seems to have taken on board the lesson of the Liz Truss ‘Mini-Budget Moment’ back in 2022, that borrowing for the purpose of uncapped public spending does not make for happy lenders.

Somewhat surprisingly, however, this episode does not seem to have made its mark internationally. Neither US political party seems keen to get to grips with public debt, while in France the Popular Front is insisting on hundreds of billions of euros of splurging, all while public debt is well over 100% of GDP. Are we due some sort of Financial Crisis redux?

At least the US has the privileged status of having the world’s reserve currency and largest economy. We have the sense, though, that public debt will carry on rising until it can’t, much like the periodic bouts of brinkmanship that arise over the US debt ceiling. As Churchill is supposed to have said, ‘you can always count on Americans to do the right thing – after they’ve tried everything else’.

France, meanwhile, has the reprieve of its political quagmire. Mélenchon’s alliance fell short of enough seats to force its way. French government bond yields have actually fallen slightly, grateful for the stasis which may grip the Fifth Republic for perhaps the next 12 months.

Furthermore, we should remind ourselves that while public debt is indeed a drag on present growth through interest payments, global net borrowing is precisely zero – we owe it to each other.

Hotter, colder

Nonetheless, a low-octane governmental baton pass such as the one we have just managed in the UK remains something to be envied. Though we are sadly not strangers to political violence or indeed assassination attempts, we have thankfully not had to pre-emptively deploy tens of thousands of riot police, neither have we witnessed candidates writing off elections as rigged.

Are we just lucky to have rarely suffered from such febrile political atmospheres, or is there something to our much-maligned electoral system that inoculates against it?

Though lambasted for its lack of proportionality, our First Past The Post (FPTP) electoral system has the infinitely greater virtue of producing (most of the time) decisive yet fragile majorities. These enable governments to legislate without compromise or back-room dealing, while preserving the all-important ability of the electorate to calmly send them packing overnight.

A curious parallel with investing is visible here – in both electoral systems and markets, error correction is paramount. As Hayek observed, markets enable individuals to make conjectures about prices of goods and services – conjectures containing dispersed knowledge of supply, demand and so on.

Each of these conjectures no doubt contains errors – as none of us is infallible and the world changes unpredictably. Well-functioning markets constantly correct those errors, providing bleeding-edge estimates of perceived value. Poorly functioning markets – those which brook no price disagreement – fail to reflect wider knowledge.

An argument for investing in index-tracking funds, therefore, is that they maximise this error-correcting potential. Perhaps there is a sense in which active managers are to portfolios what central planners are to economies.

Ultimately, both markets and governments make mistakes. It is therefore unrealistic to say ‘things can only get better’. But with sound systems of error correction, we can happily and irrefutably conclude that things can always get better.

Watch our latest Economic Update

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Investments can go up and down in value and you may not get back the full amount originally invested.

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With almost perfect timing, a week before the Prime Minister announced in the pouring rain that he was calling a general election, we held a Chatham House panel event for clients hosted by Polly Toynbee, the renowned Guardian political and social commentator. Our panellists for the evening were Dr Miatta Fahnbulleh, the Labour Party parliamentary candidate for Peckham, James Murray, MP for Ealing North and Josh Simons, Director of the political think tank, Labour Together. Here are some key highlights from the discussion.

Labour is not seen to be on the side of business. To what extent has that barrier been broken?

The panellists told the audience that when they have met businesses up and down the country the overriding message from them is that they want stability, certainty and predictability – and a government they can work with. Rachel Reeves, the Shadow Chancellor of the Labour Party, has said publicly that Labour wants to be a pro-business party working together to keep the economy growing – and the panel said that through its actions, it will prove it. Labour’s central mission is to grow the economy but the panel admitted they cannot do that if they are not in partnership with business. “This is not a political slogan; it is not a tactic. It is just the reality,” said one panellist.

However, the discussion highlighted that its partnership with business should not be short-term. Governments all over the world including Australia, the US, Canada, and Germany have recently won elections because their right-wing opponents have failed. However, it was highlighted that many have struggled since coming to power because they are not delivering material economic improvements to people’s pockets. “If Labour comes to power, it has to mean what it says about forging a ‘real relationship’ with businesses if it is to win [a second term] again,” said one.

Will accepting the same fiscal rules and treasury conventions be a challenge?

The panel were very clear that it believes it is impossible to build a credible offer in opposition without iron-clad fiscal rules. The rules, they said, will underpin everything that it wants to achieve and advocate the changes to enable private sector-led growth; it will form the foundation for getting the economy to grow. “With stability, we will be able to work in partnership with businesses to remove the barriers to investment to invest in the industries of the future,” added one member of the panel.

How confident are you in Labour’s growth plan?

One member of the panel urged the audience not to underestimate Keir Starmer’s and Labour’s commitment to implementing a new way of governing to get the desired results. But the panel are in a confident mood that they have dug into the details beyond the manifesto headline-grabbing policy to make the plan work. “The level of detail is not like what I have seen before,” said one. “There is huge confidence.”

What are you going to do about the Treasury’s black hole?

The panellists are under no illusions that the next government will inherit an incredibly difficult situation should it get a firsthand look at the Treasury’s books. Tax revenues are extremely high – yet Labour has said that it is not talking about or wanting to put up taxes. A panel member said that the NHS and schools will need a more immediate injection of cash and said that Labour will look to close some tax loopholes such as with non-doms, tax avoidance and modernising HMRC. But it goes back to growth. “The only way to get sustainable finances for public services is to get the economy growing,” added a panellist.

Do you think attitudes have changed to be more socially democratic?

All the panellists, to varying degrees, agreed that the attitudes of voters had changed and this has been evident not only by the recent local election results but also by knocking on people’s doors and speaking to them in person. “There is a sense of hopelessness and genuine anger,” said a member of the panel. But there is a bigger challenge that lies in wait. A theme throughout the discussion is that any meaningful change will take more than one term of office. Yet, governments around the world are struggling to figure out what it means to govern responsibly in today’s age. The challenge for Labour will be how, as a centre-left party, it can reassure an electorate that is more willing to switch allegiance very quickly. “That is going to require doing things differently and experimenting,” said a panellist.

What do you hope to achieve in five years, should you come to power?

The overriding hope is that it has raised living standards and that the current housing crisis shows signs of easing. One member of the panel said that its Green Prosperity Plan could be a game-changer. They said that the transition to net zero has to happen and is a real opportunity, creating jobs and growing industries. “If we get momentum and give people hope that we are turning things around, then we have a chance for a second term,” they added.

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The UK economy has experienced three years of inflation being far too high – well above the 2 per cent target, but it is now plausible that over the coming year or so it will be too low.

Inflation has declined from a peak of 11.1 per cent in October 2022 to 3.4 per cent in February this year, and I have been surprised by how quickly it has come down recently. There is a very good chance that it will fall below the 2 per cent target in April. And while many investors expect inflation to drift back up towards the 2 per cent target level, we believe it will fall to around 0.5 per cent by the end of this year.

When will interest rates be cut?

The Bank of England has publicly said that it is debating the best time to cut interest rates. If our inflation forecast is correct, that could be quite soon. We, along with many, have pencilled in a first interest rate cut in June. But what happens next is key.

If inflation does fall below 1 per cent later this year, the Bank will likely have to cut interest rates further than many expect. We believe that the current rate of 5.25 per cent could fall to 3 per cent at some point next year.

Watch the full recording

What is the outlook for the UK economy?

I am very confident that the mild recession we had at the end of last year is over. All the evidence suggests that the UK economy is gaining momentum.

The housing market is an important barometer for the wider economy, particularly when interest rates are moving up and down. House prices have started to tick up, which is positive and gives us an indication of where the rest of the economy is going.

Economic activity will receive a further boost if, as we believe, inflation falls markedly and interest rates continue to come down. This needs to be put into context – the economy isn’t going to go gangbusters. However, given there has been no growth for two years, we can say that an economic recovery is already underway – and we believe that it will be stronger than many anticipate.

What type of economy will the next UK government inherit?

While the economic backdrop is becoming more favourable for the current government, whoever wins the UK general election will still face a challenging economic and fiscal situation.

The next government will have to cope with a higher interest rate environment than we have seen for more than 15 years. Plus, there will be less scope to use fiscal policy to achieve political aims.

Cutting public spending is one solution, but it seems less politically palatable, especially for the Labour Party; it would likely opt to increase taxes instead. I suspect that the Conservative Party would conclude the same, albeit not to the same degree. We anticipate that whoever wins will raise taxes in one form or another to fund more public spending.

How will the US presidential election affect the US economy?

Unlike Europe and the UK, the US economy has been less affected by higher interest rates because many US households have 30-year fixed-rate mortgages. This means that rate hikes take longer to seep through into the economy.

While there is a slowdown coming, we believe the US economy will remain relatively strong and grow by around just over 2 per cent on average per year.

Turning to the US presidential election, it looks like a very close call between Biden and Trump, but of course no one knows what the outcome will be. One scenario, should Trump win, is whether he follows through on his comments to impose 10 per cent tariffs on all imports coming into the US and 60 per cent tariffs on all imports coming from China. It is hard to see how such tariffs would not be detrimental to the US economy as a whole. They would essentially lead to higher inflation (so households’ real incomes would be lower) and prevent the Fed from cutting interest rates as far as it otherwise might.

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Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.

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Yes, is the positive and truthful answer. This time last year, we were staring down the barrel of dark recessions, rising inflation and higher interest rates. But those recessions never materialised. This year we see the economy recovering as inflation and interest rates fall. We don’t even expect this year’s major political elections to disrupt the economy too much.

Does last month’s surprise rise in inflation derail your forecasts?

No, I believe that was a blip, rather than set a new trend. I also believe inflation will rise again next month. But thereafter, there will be a steep fall, particularly in the UK. I suspect that by the middle of the year, inflation will be back to the 2 per cent targets in the UK, the eurozone and the US – with the UK getting there first in April.

Watch the full recording

Did central banks need to raise interest rates?

Some central bankers argued inflation that started to appear in 2021 was transitory and it would have subsided, without any action. There is some truth to that – the global factors such as energy and food inflation have fallen back very sharply. However, elements of domestic inflation have endured for longer and been higher than people expected. This was triggered by the big surge in global prices, which fed through into domestic economies. So, you have some elements of inflation that are transitory and others that are trends. The bottom line is inflation would not have fallen back as far as it has done, without the sharp rises in interest rates we have seen.

Could issues in the Red Sea cause a spike in inflation?

This is a risk that I’m most worried about. With ships rerouted, companies are having to pay more for fuel, insurance and labour. This has fed through into a 200 per cent jump in shipping container costs already. That said, it is not as bad as it was during the pandemic; it doesn’t dramatically change the inflation picture and we don’t see this feeding through into the prices of goods in shops. If the situation worsens, I’d still expect inflation to fall, albeit more slowly, but we are not crystallising this thought in any of our forecasts yet.

How have we avoided a severe degree of economic pain?

It’s been such a good and favourable result. Quite remarkable frankly because everyone was expecting a deep recession with a big rise in unemployment. What has happened is that instead of weak economic demand bringing price pressures down, supply has rebounded much quicker. This means prices can be lower or rise less rapidly without causing too much economic pain. We haven’t got away completely scot-free. Economies have been stagnating, it is just that they haven’t been shrinking.

Is there still a risk of recession?

There is but we need to put it into context. Some economies may be in recession right now, certainly in Europe, but it’s how painful recessions are that count. The bigger picture is that there has not been a huge collapse in economic activity. As I mentioned before, economies are stagnating rather than going backwards.

When will interest rates be cut and when they do, by how much?

It depends on the economy and how far inflation falls but we believe we are getting close to seeing the first interest rate cuts. I think the US is probably going to be the first to move, with an interest cut as early as March. Europe may follow in April, with the UK the last to the party sometime in June. Interest rates need to get down to a level of 3 per cent in the UK because that’s where the economy can grow at a decent rate and inflation can be stable at around 2 per cent. We think it could be a pretty fast move and expect to see rates in the UK fall to 3 per cent sometime next year.

Will a cut in interest rates lead to a rebound in economic activity?

Falling inflation itself boosts the real wages of households and the real spending power of businesses. That’s already happening. People are going to feel that their money can stretch a bit further over the next year or two. At the same time, the drag from higher interest rates is starting to fade, while a cut in rates will boost spending power. That’s why we think that in the second half of this year, we will see economies emerge from a period of stagnation with the outlook looking a little bit rosier.

How will the UK election affect the economy?

We know based on polling, the Government is far behind. They will need to do all they can to improve the mood and we expect to see some tax cuts this Spring. That is another reason why economic recovery will get going in the second half of the year. After the election, there’s less scope for the Government to influence economies in the near term. Whoever wins is going to be faced with an unfavourable public finances situation – they will have to keep a tight hand on the purse. I don’t think the result will dramatically change the outlook for the UK economy over the next three or four years. That will be dictated more by interest rates and global trends – as it will in the US when it goes to the polls in November.

The Weatherbys view

At Weatherbys we believe it is important to stay abreast of economic developments, but not to make plans entirely dependent on forecasts. We are in the fourth year of a new decade and we have experienced a pandemic, conflict in Europe (which is ongoing), rising inflation and higher interest rates. Yet, financial markets have seemingly shrugged it all off and risen to new heights.

We build investment portfolios that are all-weather affairs, designed to perform solidly whatever happens – rather than going all-in on a particular expectation of what the future holds. Our position is that you are much better off putting a bit of thought into financial planning and taking broad advice where it is needed on matters of income, retirement and your broader estate – not needlessly fine-tuning a portfolio and twitching on market news.

As ever, we remain at your disposal to solve whatever financial quandaries may be weighing on your mind.

Important information
Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.

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The two main giveaways were a 2-pence cut to National Insurance, and the making permanent of previous temporary measures enabling businesses to offset investment expenditure against pre-tax profits.

Both these measures ‘cost’ roughly £10 billion in terms of foregone revenue. But of course, the Chancellor would argue that they may well end up earning greater sums over time, should they succeed in stimulating growth.

Capital Economics estimate Number 11’s net generosity at £14.3 billion, when you consider what the Chancellor took away with his other hand. This is still a sizable figure – where does it come from, you might wonder?

The answer is the Office for Budgetary Responsibility (OBR)’s revised forecasts. These prescribed prophecies have great constraining power on fiscal policy, and the future sooth was said to be one of slightly higher inflation than previously thought.

Hence, in nominal terms, the Chancellor could spend more money while still allowing for debt to fall as a ratio to Gross Domestic Product (GDP).

And speaking of that denominator – the OBR foresaw slowing growth in the coming years, with a real increase of 0.7% in 2024, down from 1.8% before.

What does the Autumn Statement mean for my personal finances?

Though some had speculated there would be eye-catching changes made to inheritance tax, or even that it would be abolished as pre-election appetiser, in the end there were no fireworks. The Chancellor perhaps opted to keep things agreeably dull for the benefit of an increasingly vigilant bond market.

Nonetheless, the changes made to pensions – allowing for consolidation – might well make life easier for the serially employed. Likewise, the triply-locked state pension, up by 8.5% or an additional £900 per year, will make a difference for some.
And there were minor changes to ISA rules: savers will now be able to open accounts with multiple providers within a single tax year, for instance.

Overall, however, there was little to provoke a re-drafting of anyone’s financial plans.

What does the Autumn Statement mean for my investments?

Gilt yields rose slightly as the Chancellor spoke. This reflected a marginally higher outlook for interest rates, given the OBR’s figures for growth and inflation. Or, to be more precise, an expectation that interest rates would be held at this level for a little longer than had previously been envisioned.

As for currency movements, the pound lost a cent against the dollar, increasing the value of US assets. And remember, it is those US assets which dominate global equities – the UK stock market is but a fraction of the world’s corporate enterprise.
The Autumn Statement therefore remains not especially salient to investors, whatever its import for us as citizens.

Conclusion

If anything, the Chancellor’s inability to meaningfully splurge in the run-up to an election year tells us more than any of the detail. For the fiscal room to manoeuvre is so tight, still so constricted by the OBR’s dour prognosis, that – barring an astonishing growth spurt – we can all but rule out a radical loosening of the belt by a government of any hue in the next few years.

As such, this Autumn Statement perhaps augurs nothing more than a political sobering, after the extraordinary policies of the pandemic. In the UK and around the world, governments are going to have to go ‘cold turkey’.

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Read the highlights…

Have interest rates peaked?

I sense that we’re starting to see a greater body of evidence that suggests higher interest rates are working, by dampening economic activity and employment growth. This will eventually result in slower core inflation and wage growth, which is why we think rates have peaked in the UK, US and Europe.

Will the rising price of crude oil throw a spanner in the works by fuelling inflation?

If the oil price were to stay at its current level of around $90 to $100 per barrel, then inflation would fall more slowly than we previously anticipated. However, when it comes to the UK, the drop in utility prices is having the biggest effect on falling inflation, and we continue to believe that it will fall to 5 per cent by the end of the year.

For our outlook to be very different, the price of oil would need to jump to $150 per barrel. And even if that were to happen, inflation could still fall, although central banks would likely keep interest rates at their current peaks for longer than planned.

Do you think that interest rates will stay, as the ubiquitous phrase goes, ‘higher for longer’?

I don’t think this will be the case in the US, because inflation looks likely to fall to its 2 per cent target much earlier than most people expect. On the other hand, the UK has a bigger inflation problem, partly because of stickier domestic inflation driven by a reduction in the supply of labour, which has boosted the rate of wage growth more than in the US. Strikes and big public sector pay deals have exacerbated matters.

So, while we expect the Fed to cut interest rates in the first half of next year, we don’t believe the Bank of England will be in a position to do so until the end of 2024.

When central banks do reduce rates, will it be just a few token cuts?

No, we believe the cuts will be more drastic than many are anticipating. The markets are pricing in rates of between 4 and 5 per cent in the UK at the end of 2025. Our view is that if the UK enters a mild recession, inflation will come down quite significantly. The Bank of England will then be able to declare victory and plan on making bigger cuts to around 3 per cent by the end of 2025.

Where do you think interest rates will settle in the long run?

We don’t envisage returning to a world of almost zero rates, but neither do we think we are going back to the interest rates that preceded the financial crisis. The norm will be somewhere in between. Before the pandemic, we thought that the so-called neutral interest rate in the UK would be about 2.5 per cent. Now, we believe rates will more likely settle at around 3.5 per cent.

Will the housing market weakness continue?

In our view, mortgage rates are going to remain in the region of around 5 to 6 per cent for the best part of another 18 months, which is high compared to the past few years. This cumulative effect will gradually take its toll on the housing market, so further weakness can be expected. Prices have already fallen by around 6 per cent from their peak a year ago, and we suspect they will fall by a similar amount over the next year or so, too.

How will AI affect productivity and employment?

We believe that generative artificial intelligence (AI) is a transformative technology that is going to filter throughout the whole economy and give a significant boost to productivity growth. The UK has had very poor productivity for the past decade, but we believe that AI could change that.

In the past, major technological revolutions have taken place in the industrial and agricultural sectors; this time it could be the turn of the services sector. And the UK has a big services sector where businesses can meaningfully innovate, adapt and adopt AI. Our analysis suggests that the US is going to be the winner from the AI revolution with the UK not far behind.

Naturally, some jobs will be lost to AI, but some will be complemented by it, and many will be created. And if AI boosts productivity, as we believe it will, it will generate a bigger economy and stimulate employment growth.

Weatherbys’ view

Ultimately, long-term changes in share prices have little to do with the caprices of economic sentiment over the short term. They have much more to do with innovation, invention and problem-solving – and AI could yet play a pivotal role.

However, we would caution against trying to pick specific winners. Some companies have done very well from AI-related speculation already, but it is plausible that the creative adopters of this technology will generate the most value in the years to come. And nobody can predict the future – not even the inventors themselves!

Instead, we engineer investment portfolios according to sound philosophical foundations – relying not on past performance or future prophecy, but fallibilism and good explanations.

As ever, we remain at your disposal to solve whatever financial quandaries may be weighing on your mind.

Important information
Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.

The post End in sight for interest rate hikes appeared first on Weatherbys Private Bank.

Read the highlights…

Before we turn to the UK, can you set the scene by establishing what’s going on in the US? Have interest rates peaked across the Atlantic?

I don’t think so – rate hikes may well have paused, but not peaked. It feels to me that inflation is still a bit too high for the Fed’s liking, which suggests that it will indeed raise interest rates further, taking the range to around 5.25/5.5 per cent.

Interest rate hikes take time to feed through into the economy, and some of the forward-looking activity indicators suggest that economic growth is slowing. This weakness is perhaps necessary to bring core inflation down – only when we see solid evidence of this will interest rates likely have peaked. My instinct is that the US will enter a relatively mild recession, but not a deep one.

Why is UK inflation still so high by contrast?

There are lots of similarities between what is happening in the US, the eurozone, and the UK. However, the factors driving inflation are more marked in the UK, ­and that is why the Bank of England felt compelled to act last month by raising interest rates to 5 per cent. Inflation just hasn’t come down as far, with UK CPI at 8.7 per cent compared to the eurozone (5.5 per cent) and the US (4.1 per cent).

The UK’s inflation problems can be found in the labour market where wage growth is much stronger – and it is this that is causing domestic inflation pressures to be greater in the UK than elsewhere.

What can the Bank of England do to bring inflation down?

The amount of aggregate supply in the UK economy has declined below the level of demand and it is this that has generated a burst of inflation. Ordinarily, to bring inflation down you just raise supply again by increasing the number of workers or increasing the amount of investment. That would be the painless way out. Inflation would just subside without any economic weakness or higher unemployment.

Unfortunately, it’s really hard to pull those levers quickly. Alternatively, you can bear down on demand by bringing it into line with supply to curb inflation. This requires some economic weakness, which means the Bank of England has to create conditions that are painful for some and painful for the overall economy.

It’s a choice between high inflation or high-interest rates. Like the Bank, I’d suggest a temporary increase in interest rates is the lesser of those two evils.

What is your outlook for interest rates in the UK?

We expect the bank to raise interest rates to 5.25 per cent at its next meeting in August – and they may yet go to 5.5 per cent. Once we get into the autumn, there should be clearer signs that the influence of higher interest rates is starting to come through.

We estimate that about 40 per cent of the increase in interest rates has been felt so far, which means there’s still 60 per cent to come through, and much of that will play out in the housing market as people adapt to higher mortgage rates.

When might interest rates fall?

We believe that interest rates will stay at their peak for a relatively long period. Historically, interest rates usually stay at a peak for just a few months, but this time it could be a year.

If, as we forecast, a recession loosens the labour market, weakens wage growth, and therefore controls core inflation by the end of 2024, maybe going into 2025, the Bank of England will be in a position to cut rates. Once we are in a stable economic environment, interest rates can come back down to 2.5 or 3 per cent.

What is the outlook for the UK housing market?

It is important to illustrate the size of the problem with mortgage rates now over 6 per cent. First-time buyers with a median income purchasing an average house could see their mortgage payments rise from 35 per cent of their monthly income to around 55 per cent.

And if you are already a homeowner with a fixed-rate mortgage expiring, then your monthly mortgage payments might jump by 50 per cent.

These are huge numbers to absorb, and some people are going to be hit hard. This will translate into lower housing activity, lower house prices, and eventually a weaker period of consumer spending in general.

For those jetting off on summer holidays, what are your thoughts on currencies?

Of all the forecasts economists make, currencies are the hardest! That said, the pound is getting an ‘interest rate boost’; it has strengthened against the dollar and euro because interest rates are expected to rise further in the UK.

However, there could well be a flight to safer assets such as the dollar if the US enters a recession. If that does happen, the pound might be caught in the crossfire and I wouldn’t be surprised if it weakened to around $1.15 against the US dollar by the end of the year.

Weatherbys view

We believe it is important to stay abreast of economic affairs, but not to make plans entirely dependent on fallible forecasts.

Ultimately, long-term stock market returns have little to do with the vagaries of short-term economic conditions, or swinging investor sentiment. It’s much more to do with innovation.

Human ingenuity carries on independent of dismal headlines – entrepreneurs create value, literally out of nothing, by solving problems in creative ways. The more universally valuable their solutions, the more value they create.

Helping our clients meet their financial goals and objectives is therefore less about fine-tuning a uniquely complicated portfolio or prophesying stock markets, and more about prudent, personalised advice that maximises efficiency and minimises needless risk.

Don’t hesitate to get in touch should you have a financial quandary we can put to rest.

Important information
Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.

The post Higher interest rates – but for how long? appeared first on Weatherbys Private Bank.

The jury is out on whether the Bank will raise rates further (or even cut them) but many economists suggest that they are nearer their peak than not. Irrespective of how rates move, now is the perfect time to review your cash deposits to ensure you are making the most of the 1600% rise in Base Rate since its all-time low.

Access to cash

At the heart of Weatherbys financial planning service is a personal cash flow plan that helps you map out your financial requirements – and demonstrate how various scenarios might affect those needs. As part of your cash flow plan, we would always recommend that you have some cash at your disposal.

Everyone’s circumstances are different of course, but we suggest you have a core wealth pot of typically three months of expenditure up to whatever allows you to sleep at night. It is always an advisable idea to keep some cash in an easy-access savings account to cover emergencies – but we offer a range of deposit accounts to suit all of your needs, with some offering higher rates than others.

Our range of deposit accounts

Our fixed-term accounts pay a fixed rate of interest on your savings for a defined period; our notice accounts pay variable rates of interest but require you to give a certain amount of notice before withdrawing your money; and our instant access accounts allow you to access your savings at any time and from anywhere. We also offer loyalty accounts that pay higher rates of interest for those of you that have banked with us for longer.

Why Weatherbys for deposit accounts?

We are flexible
As with all our services, we are extremely flexible. For example, we can create an entirely bespoke length of fixed-term deposit account for you, while we can also lend you money using your deposit account as security if you need access to your cash before the notice period matures.

We make applications easy
Unlike many banks, we keep the forms for you to complete to a minimum. Simply get in touch to enquire about opening a deposit account of your choice.

Secure 
Security is very important for depositors with savings above the Financial Services Compensation Scheme’s protection limit of £85,000. It’s why we maintain a strong balance sheet with a conservative loan-to-deposit ratio, which means we have far greater levels of deposits than we do outstanding loans. The majority of any surplus cash on our balance sheet is held with the Bank of England and can be accessed instantly.

We are highly competitive
We review our deposit rates frequently to ensure they provide a fair return to both our savers and borrowers. Following the last move by the Bank of England to increase the Bank Rate from 4.25% to 4.5%, we increased the rates on a selected number of savings products. This includes our 250 Day Notice Account that now pays 4.35% AER.

We offer value
As a private bank, we also focus on delivering value for money to our clients, which means more than just the rate of interest you get paid. We pride ourselves on providing exceptional personal service, which is evidenced by our net promoter score – an industry-standard gauge that measures customer loyalty and satisfaction – of 73. The banking industry’s average is 30.

Flexibility in action

Case study 1
One of our client’s 250-day notice account matured. They didn’t require the money for another two months but that was too soon to roll over for another 250 days. We created a two-month extension to maximise return – and match their needs.

Case study 2
Another client had £1m on a 12-month fixed deposit that was not due to mature for several months. An unforeseen property purchase meant they wanted to access £300,000. We agreed to lend the client the £300,000 needed, secured against their deposit account at 0.99 per cent over Base Rate, to be repaid when the account matures.

Our deposit accounts

Click here to view our latest deposit accounts and rates.

The post Making the most of your cash deposits appeared first on Weatherbys Private Bank.

Read the highlights…

How has news on inflation affected financial markets?

At the start of the year, inflationary pressures were fading quite fast and there was a growing expectation that central banks wouldn’t have to raise interest rates much further. The prospects were that they could actually start to look at cutting rates.

But as time went on, inflation proved to be stickier than anticipated. Central banks concluded that they would have to keep rates higher for longer, which weighed on markets.

This time last year energy prices were spiking amid the Ukraine conflict. Where are we now?

We’re in a much better place now. The winter was much milder than expected and that has contributed to a sharp fall in energy prices, which are back to mid-2021 levels.

In the UK, natural gas prices have plunged over 600 pence to just 100 pence per therm, and the oil price has fallen from US$130 a barrel to US$85 a barrel. It’s a real game-changer for the UK and eurozone as they import a lot of energy.

Can central banks declare victory over inflation?

It’s too soon, although the battle is going in their favour. Several factors are supporting continued inflation besides energy prices. But there are other domestic factors involved, and it may prove harder to get down to the Bank of England’s 2 per cent target level.

What are these domestic drivers of inflation? What keeps you up at night?

The resilience of the economies and the decline in energy prices put more money in people’s pockets. So that supports the real economy. There is also a very strong labour market and wage growth – these are inflation drivers that tend to last longer and are more of a slow burn.

What needs to change to hit the 2 per cent inflation target?

A big increase in the economy’s supply side, such as a boost in investment or productivity, will bring inflation down, or perhaps a sizeable increase in the number of people available to work. This would ease wage growth because businesses will not need to pay high wages to retain employees and attract new workers.

If you can’t get supply up to reduce inflation pressures, you’ve got to get demand down. I think this is more likely, because I don’t think we’re going to get this big burst of supply that suddenly brings wage growth and inflation back down. That’s why I believe we need a period of weak economic activity to get inflation back down to 2 per cent.

Have central banks raised rates enough?

That is the $64,000 question. My sense is that they probably have just done enough. But what’s important is that the full impact on economic activity from these rate hikes has not been felt yet.

As the effects filter through, it will trigger recessions in the UK, the eurozone and the US. It is those recessions, which will be small and mild by historical standards, that will help get inflation back down to the 2 per cent target.

There were some gloomy forecasts about the UK economy in the news recently. Do you agree with that view?

The IMF has forecast that the UK will fall into recession this year and be the worst performing G7 economy next year. I would agree with this sentiment, but I wouldn’t characterise that as being unique to the UK. I would group the UK together with the eurozone and the US. And this should be seen in the context of growth in previous years.

It’s worth reiterating that I still think a mild recession is a relatively favourable result. If we can get inflation back down to 2 per cent without interest rates going much higher, then that is a good result for financial markets. And if that does happen, recessions will be fading by the end of the year, inflation will be on the way back down to 2 per cent and central banks will be thinking about cutting interest rates.

What do you expect will happen over the coming months and the rest of the year?

The real focus is to what extent this economic weakness emerges. And if it does emerge, is that enough to get inflation back down to the 2 per cent target? The worry would be if inflation gets stuck at something like 4 per cent, as the onus will fall back on central banks to act.

If they conclude that the rate hikes made so far aren’t enough to slow the economy, then they may raise rates further or keep them higher for longer. But I think they will pause for now to see how the recent hikes play out.

How has the pound performed?

The pound has had a really good start to the year and is the best performing developed market currency. Unfortunately, I don’t think that will last.

A lot of the pound’s strength has been due to the weakness of the US dollar. Financial markets have concluded that interest rates in the US aren’t going to rise much further. Subsequently, there hasn’t been safe-haven demand for the US dollar.

If the US goes into recession over the next six to twelve months, that will change, and there’ll be a surge back towards the US dollar as investors seek safer assets. That will hurt the pound.

The Weatherbys view

While there is undoubtedly value in staying abreast of the latest economic developments, we would caution against leaning too heavily on one particular data point or forecast.

According to the latest Standard & Poor’s Index Versus Active (SPIVA) report, active investment managers in the UK had an annus horribilis in 2022 – 92 per cent failed to outperform their index. This underlines our view that it’s just not worth trying to fine-tune a portfolio to an excessive degree by attempting to pick out particular sectors or themes – these ideas are usually already well known and in the price.

Our position, which is borne out by that report, is to keep portfolios as robustly boring as possible, and instead expend our effort on our clients’ financial plans. That’s where we put all of our talent and expertise, and that is proving the right way to go.

Important information
Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.

The post Cheaper energy eases inflation – but a recession might still be required appeared first on Weatherbys Private Bank.

There have been three key drivers. First, there are signs that we are winning the battle against inflation. Second, economic indicators suggest Europe and the UK could be more resilient to the headwinds that they faced last year. And third, China’s economy has rebounded vigorously since it ended its zero-Covid policy in December.

Why aren’t we in a recession yet?

There were widespread expectations that the European and UK economies would fall into recession last year. But that hasn’t happened – their economies have been weak, but they have not fallen into a deep contraction. There has been more resilience, perhaps because governments have absorbed the hit by helping households or businesses more, or because households have still got some savings left over that they built up during the pandemic. Plus, businesses may have some cash left over from Covid bounce-back loans. That said, while Europe’s and the UK’s economies are doing better than expected, it looks as though the US is slipping into a recession.

What is happening with inflation?

Thankfully, it is starting to subside, particularly in the US where inflation is well past its peak. That’s thanks to recent falls in commodity prices, shipping rates and an easing of supply shortages. Inflation has likely peaked in the UK and Europe too, but there is less reason to celebrate, because the key difference is that, unlike in the US, there are no signs that domestic inflation has eased. The path of inflation in the UK and Europe has lagged behind the US by around three to six months – we think this will continue to be the case.

Do you think we are over the worst?

There are three reasons to be cautious. First, while inflation has come down, we can’t declare victory just yet. Second, the drag on economic activity from higher interest rates has not been felt in full. Third, while we’ve become more optimistic about the outlook for China over the near term, there are still reasons to be concerned over a five- to ten-year period. There are reasons for optimism right now, but I just wonder if people are getting a little carried away.

What are your forecasts for inflation?

The hope, and the expectation, is that inflation magically falls back to 2 per cent, which is the target that most central banks aim for, and for everything to return to normal. But there is a risk that it doesn’t, or that it falls but gets stuck at let’s say 4 per cent. If that happens, central banks may have to either raise interest rates, or hold off from cutting them. These risks are higher for the UK, where job shortages are greater and there’s more upwards pressure on wage growth, which means inflation might be less inclined to fall to 2 per cent.

How high will interest rates go?

We are forecasting the Bank of England to raise interest rates from 4 per cent to 4.5 per cent this year. However, we think the US Federal Reserve will be in a position to cut interest rates before the end of the year – if, as we expect, inflation continues to fall.

Why hasn’t the effect of higher interest rates in the UK been felt in full?

More households have fixed-rate mortgages than variable-rate mortgages. So, higher interest rates feed through into the economy at a slower rate. There will be lots of people on fixed-rate mortgages in the UK who won’t have been affected by last year’s rate increases. They won’t be affected until their fixed rate expires, which for some people might be soon, but for others might still be some months down the line. It is only when that happens that you get the full effect of higher interest rates, which is why it is too soon to declare that everything’s great – we know this hit is coming.

What is your outlook for the global economy?

I believe that some of the economic pain is yet to come, and I suspect that the US, UK and eurozone economies will all fall into recessions this year. These recessions may not be as deep as looked likely last year, which is a reason for optimism, but I still don’t think we are going to get away scot-free. There is a brighter path ahead in the second half of the year, but I am certainly cautious about the next six months.

What is your expectation for financial markets?

We are anticipating equity prices in the US, Europe and the UK to fall back at some point over the next six months. We expect the euro to weaken and the pound to fall too. But it’s important to note that these are short-term effects. If our forecasts are right, then by around the middle of the year recessions will be underway but we’ll be able to see light at the end of the tunnel. We expect inflation to be falling back and to see interest rate cuts on the horizon. There could be a genuine improvement in the economic outlook during the second half of the year, which financial markets can feed off.

The Weatherbys view

At Weatherbys we believe it is important to stay abreast of economic developments, but not to make plans entirely dependent on forecasts. Instead, we build investment portfolios that are all-weather affairs, designed to perform solidly whatever happens – rather than going all-in on a particular expectation of what the future holds.

Our position is that you are much better off putting a bit of thought into financial planning and taking broad advice where it is needed on matters of income, retirement and your broader estate – not needlessly fine-tuning a portfolio and twitching on market news.

As ever, we remain at your disposal to solve whatever financial quandaries may be weighing on your mind.

Watch the full recording…

Important information
Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.

The post Now is not the time to declare victory on inflation appeared first on Weatherbys Private Bank.