Financial Update from Brewin Dolphin - 30 June 2023
Friday 30 June 2023
In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses UK and US housing data and discusses key takeaways from the European Central Bank’s annual retreat in Sintra.
The first half of 2023 has been a period which has confounded the forecasts of experts. The economy has generally proven to be stronger than had been anticipated. The expected rebound in services has continued to support overall activity, even as product markets have eased considerably. ‘Revenge spending’ categories, such as tourism, seem to have been even stronger than hoped.
So far the market has edged higher on the fact that, all else being equal, a recession seems less likely in the near term. At the same time inflation has eased, albeit maybe a little slower than hoped.
This carries echoes of the ‘Goldilocks’ environment, which is often considered to represent the most benign investing conditions. Conditions of not-too-hot and not-too-cold inflation generally arise from an overall disinflationary environment, driven by globalisation, technological advance and a favourable balance of worker supply to demand. It is possible that some of these forces could resume in the coming years with the adoption of artificial intelligence into workflows. For now, however, figures this week highlighted a further contraction in world trade, which peaked in real terms in September last year. At the same time, labour remains scarce.
Under such circumstances, it seems likely that growth potential will be limited, restricting the extent to which growth can continue without inflation also resuming.
Ambiguity is everywhere in this late stage of the economic cycle. Zoopla reported a weak outlook for the UK housing market. The property website noted that interest rate increases are really starting to hurt borrowing capacity, which in turn is driving sellers to lower prices. Property prices have fallen modestly over the last six months. The last time mortgage rates were this high (after last autumn’s mini-budget) property prices were supported by a reduction in housing supply. According to Zoopla’s data, the current rise in interest rates is coming at a time of diminishing demand and increasing supply. So Zoopla, like Nationwide this morning, reported resilient house prices but also expects that the resilient factors (limited supply and a post-Truss lull in mortgage rates) are reversing and mean prices will fall over the second half.
Similar timing dilemmas beset the US. We have written for a few months about the bottoming of US housing data and now we see it reaccelerating. Last week saw new home construction accelerate. This week saw better sales of new and existing home sales. But anecdotally, this doesn’t seem to reflect conditions on the ground, with builders reporting very few new projects breaking ground. Perhaps the best leading indicator of this activity is pending home sales and these did decline sharply during May. That may well be reflected in declining existing home sales when June’s data is released.
There were other bright spots for activity in the US, most notably strong industrial goods orders, which might signal that an end to the weakness in manufacturing is in sight. It seems a tenuous hope, though, as the purchasing managers’ indices have shown an accelerating decline in manufacturing activity.
All of this seems at odds with improving sentiment. The US Conference Board survey of consumers showed a buoyant mood, albeit tempered by lower expectations of future spending.
Central banks meet in Sintra
Central bank chiefs met in Sintra on the Portuguese Riviera for the European Central Bank’s (ECB) annual monetary policy conference, and we heard from several of them on the outlook for policy. These considerations took place against a backdrop of continued policy challenges.
The natural state for central bank policymakers is to turn data dependent as the outlook becomes unclear. This is probably the reason for the low success rate that policymakers have of raising interest rates without eventually triggering recessions. Because monetary policy operates with long and variable lags, by the time inflation is falling, interest rates are likely already too high.
ECB president Christine Lagarde, playing host at the conference, signalled a further rate increase would be coming in July and did nothing to dissuade those expecting a further one in September. In Lagarde’s view, the risk of further action is skewed to the upside and expectations of an interest rate cut are misguided. Since Lagarde spoke, several European countries released estimates for inflation during June. These are the first estimates for a month that has not quite finished yet and could be revised. However, what is stark is the differences. Inflation ranges from 8% in Austria and 6.4% in France, down to a sub-target 1.9% in Spain. Both Austria and Germany have developed very powerful cultural aversions to inflation due to their hyperinflationary experience during the intra war years. Given the choice, they would typically have a more hawkish stance on monetary policy than many other members of the EU.
Jay Powell, chair of the US Federal Reserve, observed that the economy is growing a modest pace. He said that policy was restrictive and reiterated that the majority of committee participants felt that two further interest rate hikes are justified this year. This is largely because of the strength of services demand.
The central banker with the toughest task is Bank of England governor Andrew Bailey. Inflation has remained more persistent, even accelerating by some measures, and yet the nuances of the UK housing market mean the true impact of the rate increases to date have yet to be felt. Bailey was therefore at pains to emphasise the Bank’s data-dependent stance. However, the Lloyds Business Barometer, released this morning, will have made uncomfortable reading as it suggests companies are feeling disconcertingly comfortable with the economic environment. They are also anticipating higher staffing levels. After resilient house prices and in the glow of strong business confidence, it seems increasingly likely that a further half point interest rate increase could be due in August.
The outlier was Bank of Japan governor Kazuo Ueda, who remains very dovish. His stance has been justified in part by a relatively low inflation print. But the Japanese policy stance is complicated in that it is leading to severe exchange rate depreciation. Currently, the rate is at levels which have historically stoked discussions about intervention. However, this would be a decision for the Ministry of Finance rather than the Bank of Japan, and protecting the yen would arguably inhibit the loose monetary policy which the Bank is attempting to pursue.
The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.
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