Residential Property Market Update December 2023

As we turn the page on the calendar, it seems inflation is also turning the corner and with the New Year we are likely to see new optimism across financial markets. 2023 ends with residential house prices declining by far less than had been predicted a year earlier, inflation slowing more rapidly than anticipated, cost of living pressures reducing, and the prospect of a monetary policy pivot earlier than expected in 2024. The outlook for 2024 therefore seems much healthier, with sentiment on an upswing – but whether this sense of ‘relieved optimism’ will be rewarded by a year which will see both the USA and UK enter an election cycle amid the backdrop of unresolved geo-political issues in Ukraine and the Middle East, as well as Covid-enhanced Government debt mountains and relatively uninspiring GDP growth remains to be seen.

November’s headline Consumer Price Index (CPI) figure of 3.9% for November - a sharp decrease from October's figure of 4.6% - was the most significant surprise to the downside since early 2021 with CPI now at its lowest level since September 2021. Five-year UK bond prices fell -4% in response and 2y gilt rates also dropped ~20bps on the previous day. As a result, expectations of rate cuts are now increasing across financial markets. Market consensus is now leaning towards two rounds of base rate cuts occurring in the first half of 2024.

Another factor suggesting that UK inflation may return to the 2% target sooner than expected, is the historic lagged correlation between the USA’s Harmonised Index of Consumer Prices (HICP) and the ONS CPI. The HICP, like the UK CPI, is a harmonised measure of inflation calculated similarly to the EU's HICP. It includes the rural population in America and excludes owner-occupied housing, unlike headline US inflation.

As of December, the HICP showed a mere 2.1% in November, compared to 7.1% in November 2021. Notably, the UK CPI appears to be tracking the US HICP with a lag of around 5//6 months. This can largely be attributed to earlier monetary tightening in the US and the faster pass-through of lower energy & ‘global supply chain disruption’ costs.  

This suggests that the ONS CPI figures may have at least another ~0.5% to pass through in the next 2-3 months’ worth of figures, leading to a headline inflation rate closer to 3% by March.

Market participants and commentators are unsurprisingly becoming increasingly sceptical about the necessity of maintaining high interest rates in the medium term. Yet despite the growing public pressure, the Bank of England Governor's recent statements have reminded me of Gene Wilder in Willy Wonka & the Chocolate Factory where, as naughty child after naughty child runs off to their fate, Wonka’s forlorn warnings to “Stop. Don’t. Comeback!” are repeatedly disregarded. I can only hope & assume that an element of ‘political theatre’ is at play, with the members of the MPC more open to a policy shift than their voting record & public utterances of late have suggested.

Of course, the Bank can only act on the data it has available to it and follow its mandate, meaning it will necessarily adopt a conservative stance to policy. However, there is very much a sense now that the MPC are swimming against the tide - nearly all markets, commentators and consumers now seem to be ignoring the Bank of England’s statements from 2023 that rates need to remain high into the medium term, with the MPC increasingly being publicly accused of repeating their mistake from 2020 in ‘acting too late’ i.e. waiting for too much data before acting.

According to Allsop's CPI model, barring any new macro shocks, the Bank’s 2% target could potentially be achieved in the summer of 2024 based on the current trajectory. This is approximately a year earlier than the Bank of England's modal forecast from August this year predicted and would lead to a more rapid policy pivot in late Q1 or early Q2 than is being anticipated.

“My view is that a rate cut of -0.25% on May 9th, 2024, is now highly likely and that that will follow hot on the heels of a surprisingly generous ‘Election Season Budget’ from the Chancellor. Combined this will lead to a significant upswing in market sentiment and reduction of finance costs going into the Summer ahead of a General Election in Q4.” – Seb Says