Chart of the Week, Week 25.

This week’s chart highlights the fact that consumer price inflation in the UK held steady at 8.7% in May 2023, unchanged from the previous month’s 13-month low and above market expectations of 8.4%. The rate remained significantly higher than the Bank of England’s target of 2.0%, adding to concerns about its stickiness, and placing additional pressure on the Bank of England to maintain the bank’s ongoing tightening campaign.

Rising prices for air travel (31.4% vs 12.6% in April), recreational and cultural goods and services (6.7% vs 6.3%), and second-hand cars (3.9% vs 1.2%) were enough to offset falling fuel costs (-13.1% vs -8.9%) and slowing food inflation (18.3% vs 19.0%). The core inflation rate, which excludes volatile items such as energy, food, alcohol, and tobacco, rose to 7.1%, the highest since March 1992.

So, what next for inflation? Interestingly, the drivers of inflation have changed. One of the biggest contributors to inflation over the last year has been energy. Fortunately, we now have falling oil and gas prices. Additionally, another big driver of inflation was the price of food, which has also come in lower this month. For me, it’s good to see that both areas are now declining, which is helpful. However, we are now seeing more spending on recreation and culture. To some extent, this is a seasonal effect, as people are likely to spend more in this area during the summer months. I fully expect spending in this area to trend down over the coming months as higher mortgage costs begin to bite when more and more people renew their mortgages at higher rates, which will reduce their spending power. Ironically, this is a much talked about topic in pubs and restaurants across the country, and I expect many people are sticking to the mantra of ‘keep calm and carry on’, so that they can enjoy the summer months with the knowledge that they will be spending less this winter.

What does it mean for interest rates? Prior to the inflation reading, markets expected the Bank of England to stop raising interest rates at 4.75%. Now, as a result of the inflation figures, they expect a hike to 5% this week. That shows you just how important one piece of data can be. So, just because they now expect interest rates to peak at 6%, doesn’t mean that will actually happen. All it might take for markets to re-assess again is for the inflation rate to undershoot expectations at some point in the coming months, or for employment to wobble, or for any other sign of cooling.  

And lastly, what does this mean for mortgage holders? This is bad news for mortgage holders. More than 1.4 million households in the UK are facing the prospect of 6% mortgage rates when they renew their fixed-rate mortgages this year. The majority of fixed-rate mortgages in the UK (57%) coming up for renewal in 2023 were fixed at interest rates below 2%. Those deals that are due to mature through the course of 2024 will be from two-year fixed rate deals made in 2022 and five-year fixed rate deals made in 2019, when mortgage rates were generally higher than 2%.

Unfortunately, I don’t have the ability to fix the UK’s inflation problem. However, as a multi-asset manager, I do have the ability to limit the impact such events will have on our portfolios. Sticky inflation in the UK is likely to force the Central Bank’s hand, which means more rate rises to come. Ultimately, this will put pressure on households through higher mortgages, which will lead to less spending, which is the government’s way of tackling inflation. Unfortunately, this increases the likelihood of a recession in the UK, and this is one of the reasons why we are less constructive on UK equities relative to other regions. At our most recent tactical asset allocation meeting we decided to move underweight UK equities. There are always opportunities in markets, and multi-asset solutions provide you with a broader toolkit to enable clients to benefit from diversification at an asset class, regional, sector, fund, and stock level. In essence, you are getting multiple layers of diversification and you have a team of expert investors evaluating what’s going on and making changes, so you don’t have to.

Takeaway: Focus on the things you can control, like selecting a sensible investment partner.

Did you know: As China’s economy falters, top US corporate executives are making it a priority to meet Indian Prime Minister Narendra Modi during his state visit to the White House. Apple CEO Tim Cook, Google CEO Sundar Pichai, Microsoft CEO Satya Nadella and FedEx CEO Raj Subramaniam will be among the several US CEOs attending the White House state dinner Thursday. Click here.

Marlborough Podcast: In this week’s podcast, wediscuss differing Central Bank policies, the UK economy and the mortgage market. Click here.

Marlborough Video: Citywire speaks to Marlborough’s Nathan Sweeney and Ruffer’s Duncan MacInnes on whether we are entering a new inflationary era. Click here.

Source: Marlborough Multi-Asset Investment Team, Trading Economic, ONS, CNBC, Citywire.