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Has there been a turn in the inflation tide?

An August 2023 Market Update by Hilltop Credit Partners (HCP) has revealed that the recent pull-back in rate expectations is providing relief to a slowing economy and housing market.

June’s inflation data was a much-needed shot in the arm for the UK economy, housing market and financial markets, coming in below expectations for the first time this year. Inflation fell to a 15-month low of 7.9% year-on-year, down from 8.7% in May and below expectations of 8.2%. Importantly, core inflation fell for the first time in five months.

The data has helped to reign in expectations for the future path of interest rates. Over the past three months, market expectations for “peak BOE rates” had increased markedly from ~4.75% to ~6.5%, with some market observers predicting rates as high as 7%.

However, following a round of softer economic, labour market and inflation data over the past several weeks, markets are now pricing in peak rates of ~5.75%, and HCP believes that over the next quarter, these expectations are likely to fall further.

Why? The report states: 'The Bank of England may well begin to realise (finally) that just as it waited too long to begin raising interest rates, it is now behind the curve again, hiking too aggressively amid mounting evidence that “hot” headline inflation and wage data has been masking an unfolding slowdown as the impact of 13 consecutive rate hikes works its way through the economy.

'In the labour market, for instance, payroll data for June clocked in at -9k, significantly weaker than the +23k consensus forecast, while the single-month unemployment rate jumped to 4.3% – the highest level since mid-2021 and in-line with the BOE’s estimate of its “equilibrium rate”.

Further, availability of candidates for new jobs rose in June at the sharpest rate since the height of the UK’s Covid restrictions in 2020, while job vacancies fell at the sharpest rate since 2009.'

HCP adds that in the construction sector, prices for key building materials like steel, reinforced concrete, and timber are currently falling at rates of -20% year-on-year, with the BCIS (Building Cost Information Service) estimating that overall annual residential build cost inflation slowed from 15.5% a year ago to 1.5% in June, reflecting both a general easing in residential construction activity and gradual re-calibration of supply chains post-pandemic, plus the disruptions caused by the ongoing Ukraine war.

Recent trading updates from large housebuilders also suggest product availability is improving and that overall cost inflation will continue to ease through 2023, potentially giving developers more of an incentive to take new or stalled projects forward.

Nonetheless, it is clear that the past year’s aggressive rate hikes are putting downward pressure on housing market activity, with first-time buyer mortgage payments as a percentage of take-home income up from ~28% pre-pandemic to ~40% in Q2 2023.

Though UK house prices were basically flat in June and July, putting them down just 4.5% from their Q3 2022 peak, and housing sales agreed across the country continued to rebound to just 2% below 2019 levels.

One ray of light for UK real estate investors and developers is the fact that UK rents rose by 3.8% in the three months to June and are currently 10.4% above year-ago levels and 29.0% above pre-pandemic levels, according to HomeLet.

Tenant demand continued to grow in June, according to RICS, while available rental stock also continued to fall, with new landlord instructions plunging to their lowest levels since mid-2020 and reports of a 35% drop in available rental supply vs. 2019 levels.

HCP expects this trend to continue, stating: 'With rental demand continuing to rise, fuelled in part by intensifying mortgage affordability issues, and available supply continuing to fall against the backdrop of increasingly hostile policies towards private landlords, we believe the path is clear for above-trend rent growth over the next 3-5 years, with a clear opportunity emerging for professional developers and operators of modern, affordable BTR stock.'

The report concluded: 'For the time being though, housing construction and delivery appears set to slow materially. Brick inventories, inversely related to new housing activity, are up by 58% year-on-year in May. New housing starts have now fallen to their lowest level in over two years, while guidance and analyst forecasts for the large publicly traded UK house builders suggests new completions could fall 30% by the end of 2024. This would imply industry-wide delivery of sub-200,000 units for the first time in a nearly decade and should be a supportive factor for supply/demand balances in an otherwise challenging market.'

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