Reasons to be cheerful...

At HQN’s stress testing event earlier this month, two housing finance experts shared their thoughts on the prospects for the UK economy in 2023. And while there’s no doubt there are still tough times ahead, they believe there are reasons to be cheerful about inflation and interest rates.

“I am looking at things from a glass half-full perspective. There’s little doubt that we’re seeing a combination of rising inflation and slow growth – in the 1970s this was known as stagflation – but we need to be sceptical about people saying inflation and interest rates will continue to soar in 2023, because the evidence tells us that they won’t.

“The current estimate is that 5% or 6% of the current 10% CPI inflation figure is due to the higher cost of imported commodities, such as oil and gas. This explains why the Bank of England’s Monetary Policy Committee appears so laid back – they’ve deduced that a large chunk of current inflation won’t respond to higher interest rates and monetary policy will have little effect in the short term because interest rates take up to two years to reduce inflation. There seems little point in the Bank of England pushing up rates quickly if the intended outcome takes too long to have an effect.

“There are grounds for optimism. Gas prices have fallen dramatically lately. What’s happened is that other countries have stepped up to fill the gap left by Russia. What’s also happening is that Russian gas sold cheaply to China and India is displacing gas that would have been bought from the Gulf and is being released back to Europe. This means there’s no less gas available, which is why prices are coming down.

“Shipping costs also went through the roof during Covid but recently they’ve fallen sharply. Equally, retail food prices have been hit by high inflation but wholesale prices are now on the wane. Key food stuffs, apart from cereal, have started to come down in price.

“The Bank of England seems to be slow in reacting to inflation. It’s been warning of a recession in 2023 but it’s also looking at core inflation, when you take energy costs out of the equation. The Bank of England’s logic is that if energy prices don’t rise any more, inflation (which is calculated over a 12-month period) is going to fall rapidly next year without any intervention on their part. Their concern is that second-round inflation will rise as energy prices fall away and will be sustained for longer. “There’s room for optimism:

• Inflation will come down but it may take three of four years to get back to 2%. Nevertheless, we should expect inflation to fall quickly next year down to about 5% by the end of 2023, thanks to a combination of falling energy and commodity prices, an increase in trade, and a government easing its fiscal policy ahead of a general election in late 2024

• The Bank of England says the market is too pessimistic in its predictions for interest rates with many experts forecasting 5% or 6% next year when they estimate they will peak at 4%

• For the pessimists, there’s going to be a recession but if this is the case, interest rates are likely to fall anyway.”

“I’m an optimist at heart and I’m going to echo Adrian’s view. S+P forecasts that CPI will fall next year with an average through the year of 5.8%. However, for the last quarter of 2023, we forecast CPI inflation will be at 1%, so in our view it will come down quite quickly. For the following two years, we’re forecasting 1.6% and 1.7%.

“We expect interest rates to peak in 2023 at 3.5% then heading down to 2.5% for the following two years.”