3 March 2023: Housing faces possible collapse

The makeup of the UK economy is such that when the Bank of England is faced by the need to change its monetary policy to either stimulate, or restrict activity, the property market is normally the first sector to be affected.

The reason for this is the knock on effect of the decision to either move or stay put, has on the rest of the economy. What starts with a decision to upgrade the family home leads to increased activity in several different areas.

The services sector is stimulated with estate agents, banks, insurance companies and the legal profession all seeing an increase in activity as well as more artisanal areas like movers, decorators and landscapers.

This activity generally begins with existing home sales but quickly spreads to new builds, where first time buyers often denude their savings to provide a deposit. This reduction in the savings rate also stimulates economic activity.

While a cut in interest rates stimulates the economy, the opposite is true for a scenario where rates are rising. It starts with a decision to maybe stay put as mortgage rates rise and householders see an increase in their monthly payments. This is also true of making any alterations to an existing property, and knocks-on all through the economy.

In the current environment, with the Central Bank having raised interest rates, it has been a gradual process as the incremental increases have been little and often.

Now, as short term rates reach a level where they are restricting activity, a slowdown in activity is being seen. The most recent data for house prices, released, saw prices fall for the first time in three years to their lowest level in more than a decade.

At this point, the Bank of England will see the tangible effect of tighter monetary policy and will need to consider just how much further rates will need to rise, since they are clearly having a restrictive effect on activity.

As inflation falls, the Bank will call an end to rate increases and rates will remain unchanged for an unspecified period until prices stabilize at a lower level.

Because the primary cause of higher inflation is an increase in demand which has a number of causes, as is seen by the current shortages of basic foodstuffs increasing interest rates often has a limited effect.

The next MPC meeting will most likely take place with inflation having fallen for the fourth consecutive and the committee will surely begin to face some tough decisions as there is sure to be a lag between tightening of monetary policy and its effect on economic activity.

One further effect of Bank of England monetary policy is the effect of changes in interest rates on the currency.

While traders see comparative changes in rates between the countries rates as a driver of the currency, currently most G7 nations are in a rate hiking cycle the market will use their instinct when they will taper their increases as an aid to making decisions on FX positioning.

Yesterday, Sterling fell to a low of 1.1924 as traders saw the weak housing data as a sign that the Bank of England may soon halt rate increases. It ended at 1.1950 and having closed below the important support at 1.2000, it may encourage further weakness.

Fed Governor, Phillip Jefferson, expressed his concern about the possibility of the Central Bank considering raising its target for inflation, which makes up a significant part of its mandate.

Jefferson feels that moving the goalposts when it is struggling to contain inflation is tantamount to admitting that it doesn’t have the tools to bring inflation back close to its existing target.

While he also believes that there is undue concern over the target as an absolute as long as the FOMC is working towards it, and policy decisions are geared towards cutting demand, inflation should follow.

Jefferson feels that Jerome Powell has been so chastened by his faux pas in labelling rising inflation as transitory that ever since he has been on a mission to bring it back under control. Jefferson, believes that it is time to stop trying to make up for that and be reactive to the current situation where the economy is possibly on the cusp of a recession.

The Democrat Senator for Massachusetts, Elizabeth Warren, has been a vocal opponent of Jerome Powell for some time. She opposed his reselection for a second term as Fed Chairman.

Yesterday, she warned President Biden to think carefully about who he chooses to replace Lael Brainard who resigned a couple of weeks ago to take up a new role as Chairman of the President’s National Economic Council, although she remains the favourite to replace Powell as Fed Chairman.

Warren says that unless Biden chooses a candidate who is strong enough to stand up to Powell, who she believes has become almost reckless in his pursuit of his goal to lower inflation, she will struggle to support him in Congress.

Warren clearly has her sights on another shot at the Presidency, having finished third in the race in 2020.

The data for weekly jobless claims is still taking on a significance that hasn’t been seen in the past, especially in the week prior to the release of the monthly employment report.

Jobless claims have been trending lower since the start of the year. A headline figure and a four-week average of below 200k tends to push the market towards a view that the NFP data will be strong.

The latest report shows that jobless claims were at 190k dons from 192k in the week to February 24th and the average fell to 193k.

The dollar index rose to a high of 105.18 as the market drew inspiration from the data. It is likely to remain supported, as the service’s output data to be released later is expected to show continued expansion.

The index eventually fell back to close at 104.98.

Isabel Schnabel an economist and member of the ECB’s Governing Board is a staunch supporter of the Teutonic belief that inflation is the most serious danger facing the Eurozone economy currently.

Ms. Schabel supports the President of the Bundesbank on the Board and is vigorous in her belief that interest rates will need to continue to rise until inflation is brought down close to the ECB target of around 2%.

Yesterday, she was looking at the fight against inflation through the lens of the size of the Central Bank’s Government bond portfolio. The bank’s stock of bonds is a legacy of the support it provided to the most indebted Eurozone members when they faced problems selling bonds as the entire economy faltered at the height of the Pandemic.

While the ECB is committed to reducing the size of its balance sheet, this is not only reducing its ability to lower inflation, but may be adding to the problem.

It is likely that her views will bring consternation to Rome, but also Lisbon, Madrid and Athens, because although the economies of Portugal, Spain and Greece are improving they will not want to market flooded with their paper since it will create difficulties for them in issuing new or replacement bonds with longer maturities.

The ECB wants to move away from the market’s perception that it is the implicit lender of last resort, always ready to step in to buy any bonds that are not finding buyers at acceptable rates.

That is not part of its mandate and as such despite the fact that is has been forced by circumstances to take on such a role it needs to divest itself in order to concentrate on monetary policy and market regulation.

Preliminary inflation data for February in the eurozone as a whole was published yesterday. And the fact that it fell when several of its components rose caused something of a welcome surprise for the ECB.

It fell from 8.6% to 8.5% although given the fall in energy prices it is food price inflation that continues to be an issue.

With any speculation about the next move in interest rates now moot, the data had little effect on the single currency, which fell marginally to 1.0576, closing at 1.0600.

Have a great day!