Caught by surprise on inflation, the only way is up for mortgage payments

UK gilt prices plunge as worries spread that Bank of England is losing control of situation

The Bank of England in the City of London. Bond yields are soaring in the wake of Wednesday's inflation figures and questions are being asked if the Bank of England has misread inflation. Bloomberg
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UK bond markets are closing out the week upended by the release of stronger-than-expected inflation figures on Wednesday, raising fears that interest rates, and subsequently mortgage rates, could soon be on the rise.

Prices of gilts – UK government bonds – plunged on Wednesday and Thursday, meaning that the yields on them, which move inversely to the prices, surged by between 1.1 per cent to 1.7 per cent.

Analysts say the reason is the growing worry that the Bank of England is losing control of inflation and that interest rates will have to rise much more than previously thought and remain higher for longer.

On Wednesday, the Office for National Statistics said that while headline inflation fell in April to 8.7 per cent from 10.1 per cent in March, core inflation – which strips out factors such as energy and food – actually rose to 6.8 per cent in April from 6.2 per cent March.

Earlier this month, the Bank of England raised interest rates to 4.5 per cent, the 12th consecutive hike. Markets are now pricing in a peak of UK interest rates at 5.5 per cent later in the year. Some analysts predict rates could even surpass that.

“To me it suggests there will be a number of interest rates hikes still to come and these are going to see mortgages rise quite sharply,” Stuart Cole, chief macro economist at Equiti told The National.

“I don’t think the markets were expecting this and this is why we are now seeing some volatility in mortgage rates as the banks are effectively having to reprice their products.

“On the bond markets generally, I would not go so far as to say they have been in chaos, but certainly bond prices have moved lower and yields higher as the market has been forced to re-price a higher terminal rate here.

“Remember, it was only a couple of weeks ago when the Bank of England delivered its latest economic forecasts, and the bond market was pricing off the better outlook for inflation that those forecasts presented.

“This week the reality hit that the Bank of England was some way off with its projections, and so we have seen a rapid re-pricing,” he added.

Russ Mould, investment director at AJ Bell told The National that the markets were caught by surprise by the inflation numbers, given the Bank of England's recent forecasts.

“Markets had begun to convince themselves, possibly slightly led up the garden path by the Bank of England, that the battle with inflation was being won,” he said.

“Clearly, we're caught on the hop when inflation transitory narrative did not prove correct. And I think they [the Bank of England] are also very much open to accusations that they are still behind the curve.

“Governor [Andrew] Bailey is doing his best to deflect that – the war in Ukraine and oil and gas are easy things to point to, to try to obfuscate. But it does feel like they are behind.”

Some experts believe Bank of England Governor Andrew Bailey has been 'behind the curve' in tackling inflation. EPA

Getting the balance right

On Thursday, the yield on the two-year gilt, which is especially sensitive to interest rate forecasts, rose 1.8 per cent on Thursday, to its highest level since late September last year.

The UK's largest asset manager, Legal & General Investment Management, made the decision on Thursday to avoid long-term investments in UK gilts for the time-being, because of the uncertain outlook.

“The inflation data that we got yesterday [Wednesday] in the UK will put a lot of pressure on the Bank of England in getting this balancing act right,” L&G's chief investment officer, Sonja Laud said.

Earlier this week, before the ONS released the inflation April numbers, the International Monetary Fund revamped its earlier forecasts, which showed the UK falling into recession this year.

The IMF predicted on Tuesday that the UK economy would grow by 0.4 per cent this year, having forecast just a month before that it would contract by 0.3 per cent.

“I doubt that the IMF would have been so notably more optimistic about the UK economy had it been able to see this week’s inflation report,” chief economic adviser at Allianz and president of Queens' College, Cambridge, Mohamed Aly El Erian told The National.

For sale signs in Islington, north London. Mortgage lenders have already increased rates on new products and withdrawn some from the market

Mortgage payments rise

As the financial markets are now pricing in interest rates to rise to 5.5 per cent by November, one of the UK's biggest mortgage lenders, Nationwide Building Society, said it will increase interest rates on many of its new mortgages by 0.45 per cent from Friday.

Other lenders, including Lloyds, Virgin Money and Halifax, all announced small mortgage rate rises on Thursday and more are expected in the coming days.

“In the interim, it’s bad news for all kinds of mortgage borrowers,” Sarah Coles, head of personal finance at Hargreaves Lansdown told The National.

“Those on a fixed rate are protected for now, but for those waiting and hoping for fixed mortgage rates to fall in order to move on to a fixed rate deal, there could be a lot more waiting and a lot less hope.

“Rising swaps rates mean fixed rate mortgages will be pushed higher in the short term.

“Meanwhile, concerns about the stickiness of inflation are likely to mean we won’t get Bank of England cuts this side of the New Year, so mortgage rates are unlikely to head south as fast as people were hoping,” she added.

British Chancellor of Exchequer Jeremy Hunt said the only path to sustainable growth is to bring down inflation. EPA

Meanwhile, Chancellor Jeremy Hunt has reiterated that the Bank of England needs to do all it can with interest rates, even if that risks tipping the UK in recession.

When asked in an interview with Sky News, if he was comfortable with the Bank of England acting to bring down prices, even if that led to recession, Mr Hunt said: “Yes, because in the end inflation is a source of instability.”

“If we want to have prosperity, to grow the economy, to reduce the risk of recession, we have to support the Bank of England in the difficult decisions that they take.”

“It is not a trade-off between tackling inflation and recession. In the end, the only path to sustainable growth is to bring down inflation.” he added.

Given the choice, many analysts say Mr Hunt is right – a shallow technical recession is far more preferable than persistent inflation, which can bring with it the risk of stagflation.

“I think in the end, the long-term damage wrought by inflation is greater than the damage wrought by a recession, which let's face it, we've had lots of them since 1900,” said Mr Mould of AJ Bell.

“We've come through them and they're not pleasant, but they are what they are. A recession can sometimes be a catalyst for good things to happen in terms of new technologies and productivity tools.”

A market stall in London. Despite overall inflation falling to 8.7 per cent in April, food prices are still rising at more than 19 per cent, according to the Office for National Statistics. EPA


Nonetheless, for some economists, the spectre of stagflation could be starting to emerge, where high inflation is coupled with low economic productivity.

“Unless Bank of England action is accompanied by a stronger government policy effort to improve UK productivity and supply responsiveness, the risk of stagflation will increase,” Dr El Erian told The National.

“With that, households will worry not just about the impact of higher prices on their purchasing power, as well as more onerous borrowing costs on mortgages. They will also worry about the security of their future stream of income.”

Some economists argue that given the rate and 'stickiness' of inflation combined with current productivity levels and economic growth, the UK is already experiencing stagflation.

Others, like Mr Mould, say current conditions mean it may not be far away.

“It would be the worst of all worlds. Because we only really experienced once in the 1970s, it still seems an outlier outcome,” he said.

“But given that global growth really hasn't been that strong since 2008, and debt has piled up, it is becoming more of a possibility.”

Updated: May 26, 2023, 1:59 PM

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