10 May 2023: Mortgage bombshell predicted

Hundreds of thousands of homeowners in the UK face the prospect of significant increases in their mortgage payments as cheap mortgages, that were agreed before the Bank of England began to hike interest rates, mature. This will add to the level of core inflation and could lead the Bank to prolong its policy of hikes that was expected to end following tomorrow’s meeting of the MPC.

Following the somewhat inconclusive results of the local elections that were held last week, the prospect of a coalition between the Labour and Liberal Democrat Parties has become a serious prospect.

It is the outcome that neither Party would want and would create real issues for the recovery of the economy.

The Labour Party’s concerns are such that they would consider forming a minority Government which would be unlikely to survive for long and end with another election in 2025 which would add to the uncertainty around the long-term nature of any recovery.

This would be considered preferable to a formal agreement which would see them have little choice but to make several Lib Dem MPs, Ministers and Cabinet members. It would see the Lib Dems push their agenda for carbon neutrality forward to the detriment of growth and output and seriously hamper the Labour Party’s manifesto commitments.

Tomorrow’s meeting of the MPC will see rates hiked again, by a further twenty-five basis points which will see them firmly in restrictive territory.

The Bank won’t want to either raise rates again or leave them at this elevated level for an extended period, but with inflation unlikely to fall much below double figures before the summer they may be left with no choice, which runs the risk of tipping the economy into recession.

This is despite the economy beginning to show signs of solid recovery with services output motoring ahead.

With other developed nations seemingly also coming to the end of their own rate hike cycles, the UK doesn’t appear to be alone in making tough monetary policy decisions. In the U.S. the Fed is likely to end its cycle and be more data-driven. A luxury that the UK doesn’t yet have.

Yesterday, Sterling closed virtually unchanged versus the dollar on the day at 1.2620 as traders decided to wait for any signals to come from tomorrow’s MPC meeting. The voting is expected to be 7-2 in favour of a hike, with the two dissenters voting for no change.

The verdict in the private prosecution of former President Donald Trump for historical sexual abuse was delivered yesterday, and it dealt an almost certain death sentence on his plans to run again for the Presidency next year.

It is unlikely that he would be able to gain the backing of the more conservative members of the Republican Party, particularly as he still faces criminal charges over his business affairs.

The outcome of the next meeting of the FOMC is far from certain. The President of the New York Fed, John Williams reminded markets yesterday that the Central Bank has not said that it is done hiking rates, with the markets possibly getting ahead of themselves.

In Williams’ opinion, the Fed has made incredible progress on monetary policy this year and isn’t about to jeopardize that by ending its cycle of rate rises when it is so close to achieving its goal of bringing inflation back to its target.

Generally speaking, supply and demand remain out of balance, while that situation is unlikely to change until the third or maybe even the fourth quarter.

Williams is unable to envisage a scenario in which the Fed is forced to cut rates this year as the economy is still showing signs of growth, albeit not at the level the Fed desires, although there is no baseline forecast for a recession.

The only current reason to end the cycle of hikes is a credit squeeze, but the markets are beginning to respond to the actions of the Treasury to protect banks.

The U.S. is unlikely to see a full-blown credit crunch which is the only event that would knock the economy off course.

Today’s release of inflation data for April is unlikely to affect the Fed either way despite the headline increasing month-on-month. The annual rate of inflation is likely to be unchanged at 5% while there is likely to be a marginal fall in the core from 5.6% to 5.5%.

Yesterday the dollar index continued its tentative recovery. It rose to a high of 101.86 and closed at 101.65. The next resistance is at 102.20 which may be tough to break unless there is conclusive evidence that the Fed hasn’t ended its rate hike cycle.

The current stubbornly high rate of inflation is proving far more comfortable to the small nations of the Eurozone which are far more used to dealing with constant price rises than their larger Eurozone partners.

In the first quarter, we saw above-trend growth from Spain, Italy and Latvia, while Portugal and Ireland both saw a significant improvement. These countries, as well as Greece and Cyprus, both of which have made incredible progress over the past ten years in bringing their public spending under control, are beginning to see their economies flourish.

With tourism likely to be a major earner again following the turbulence caused by the Pandemic, it is a distinct possibility that Southern Europe could make a serious contribution to staving off a full recession in the entire region.

Yesterday the Governor of the Cypriot Central Bank spoke of his expectation that the Cypriot economy will grow at a higher rate than that of the Eurozone in general. The country had been affected by the shocks of the energy crisis, the pandemic and Russia’s invasion of Ukraine in 2022 which had seen the economy struggle, but with inflation retreating and a full tourist season to look forward to the economy will move forward positively.

Philip Lane, the ECB Chief Economist spoke yesterday of his view that inflation is moving slowly in the right direction but hasn’t yet achieved the necessary momentum.

Speaking following the latest ECB rate hike decision, Lane said that core inflation remains too high while food prices continue to rise, an issue created by the continued war in Ukraine.

With the Central Bank continuing to hike rates for at least two more meetings, investor confidence in the region fell in April as concerns were raised about an overall recession in the region. It fell to its lowest level since January with the current situation slipping to -7 from -4.3 in March.

The euro is facing a tough time making progress against the dollar. It is akin to pushing a boulder uphill in a strong headwind, according to one bank yesterday.

It fell to a low of 1.0941, closed at 1.0962 and is in danger of testing support at 1.0920 if credit conditions in the U.S. cause any further fall in sentiment.

Have a great day!