5 July 2023: Five-year fixed rate mortgage rate averages above 6%

There was some good news and some bad for the Bank of England and the economy yesterday.

The average interest rate on a five-year fixed mortgage reached 6% as the home loan market continued to react to the prospect of the Bank adding further hikes to the base rate. This will reverberate throughout the entire housing market and the wider economy.

The good news came from J.P. Morgan, who published a report in which it exonerated the Bank from the blame for the increases that have taken place over the past eighteen months.

The U.S. Bank which has its European headquarters in the City, argued it had “little or no choice” but to continually raise interest rates since a failure to do so would have led to a deeper downturn, even though it believes that the country faces a mild recession in the Autumn/Winter.

It is hard to blame the Bank of England for “simply doing its job,” the report went on to say, particularly since neither politicians nor analysts have not offered any viable alternatives.

With headline inflation unchanged in May and core price increases at their highest level for 31 years, the public’s confidence in the ability of the Bank to bring inflation under control is at a record low. The report did, however, condemn the makeup of the Monetary Policy Committee, which “gave the impression” that its independent members were there to “simply make up the numbers.”

Although Swati Dhingra, Jon Cunliffe and until this month, Silvana Tenreyro provide some balance to the argument, ultimately their views are not acted upon since the other members of the Committee, who are drawn from the management team, provide an unassailable majority, and even if one of two have opinions that differ from their colleagues, they still vote as a bloc.

Andrew Bailey recently countered claims that he would welcome recession as a way of finally beating high inflation, by saying that “we are not desiring a recession, but we will do whatever it takes to bring down inflation.”

Overseas investment is in danger of falling to its lowest level in several years. Although there have been headline-grabbing deals announced with Japan, India and just this week, Bahrain, investment in general continues to fall due to the “unhelpful conditions” created by the current state of the economy.

The market was quiet yesterday as the U.S. celebrated Independence Day. The pound made a little ground but remained in its recent range. It rose to a high of 1.2739 versus the dollar but quickly settled back to close at 1.2713.

While most of the country was off celebrating America’s gaining independence from Great Britain almost two hundred and fifty years ago, there were still those who were agonizing over the outcome of the next FOMC meeting, which will take place in three weeks’ time.

The minutes of the most recent meeting will be published today, and along with the June employment report, due for release this Friday, and inflation data, due the week after next, a picture will be drawn of the prospects for a longer pause in the Fed’s cycle of rate increases.

Inflation remains an issue across the entire developed world, with the entire G20 continuing to hike rates. It is likely that rates will continue to rise for the rest of this year as the cyclical nature of the global economy resets after “once in a generation” levels of support were provided during and immediately after the Pandemic.

Jerome Powell spoke earlier this week about the size of the problem that is facing regional banks as the commercial real estate sector falters after a prolonged period of growth.

Higher interest rates were blamed for the failure of three regional banks earlier in the year, and it is a similar issue now as an “urban doom loop” threatens.

Again, it is the banks that will suffer as they try to extricate themselves from, according to Powell, $2.6 trillion of doubtful loans that use commercial real estate as collateral.

Not only has the rise in interest rates been an issue, however cyclical that may be, but a general shift to remote working has left demand for office space in decline. The shift that set in as part of the reaction to the Pandemic is unlikely to be reversed, but the shift in people’s work/life balance has meant that home or hybrid working is now the norm.

Cities are already beginning to experience lower property tax revenues which leads to them lowering their budgets for several civic services, which may lead to seventies urban decay.

With the FOMC hiking rates two or three further times this year, there may be an issue growing that until now has been hidden by the market’s infatuation with monetary policy, while what is happening in the “real economy” has been ignored.

The dollar index was becalmed by the Independence Day holiday. It managed to gain marginally, making a high of 103.15, closing at 103.13.

The Mighty have spoken! While there are continued speeches being made by Central Bankers from Belgium, Austria, Italy and Portugal, the President of the German Bundesbank waded into the argument about the continued tightening of interest rate policy yesterday.

While it is interesting, but predictable for the market to hear the views of the more hawkish or dovish members of the ECB’s Governing Council, the comments of Joachim Nagel are less common and carry more weight, particularly with Christine Lagarde.

Yesterday, Nagel, who keeps a lower profile than his predecessor, spoke of his view that the ECB still has some distance to travel in its quest to lower both the headline and core rates of inflation.

While he believes the causes of high inflation have been both unavoidable and cyclical, the authorities, nonetheless, have a duty to respond positively and aggressively, since high inflation for a considerable length of time will destroy the economy far more easily than a short, shallow recession.

Nagel went on to say that he also supports the shrinking of the ECB’s balance sheet, still bloated by bound holdings that took place during the pandemic, which also has the effect of tightening monetary policy.

Inflation remains well above the 2% target leaving the Central Bank on course to hike for a ninth consecutive time this month and still leaving the possibility for a tenth in September.

He acknowledged that doubts about further rate hikes are growing and will continue to grow, but he and his fellow hawks see cooling demand by raising rates as inevitable.

Nagel’s comments are a direct challenge to those made by politicians in Italy b and Portugal in recent weeks, while ECB President remains firmly in the “hawkish camp.”

While headline inflation fell for the seventh time in eight months in May, there is still work to be done to match those falls in the core.

Nagel went on to say that the bloating of the ECB’s Balance sheet was the result of excessive bond purchases and loans to banks while inflation was too low, flooding banks with cash and now that flood needs to be mopped up.

The ECB will hike by twenty-five basis points this month, then its members will disappear on holiday for August, returning galvanized for a further hike at the September meeting.

The euro lost ground yesterday in a thin market. It fell to a low of 108.76 and closed at 1.0879.

Have a great day!