Bank of England must ‘create recession’ to fight high inflation, Hunt advisor says, as mortgage rates rise again – as it happened

Time to recap, after a day dominated by depressingly high UK inflation.

The Bank of England might need to spark a recession to finally get price rises under control, an economist who advises Chancellor Jeremy Hunt has warned, as inflation remained persistently high in May.

Karen Ward, chief market strategist EMEA at JP Morgan Asset Management, told Radio 4’s Today Programme that the BoE must fight against a wage-price spiral taking hold in the UK.

Ward said:

“The difficulty for the Bank of England – I mean, no-one envies them their job at the moment – is they have to therefore create a recession,” she said.

“They have to create uncertainty and frailty, because it’s only when companies feel nervous about the future that they will think ‘Well, maybe I won’t put through that price rise’, or workers, when they’re a little bit less confident about their job, think ‘Oh, I won’t push my boss for that higher pay’.

“It’s that weakness in activity which eventually gets rid of inflation.”

Ward was speaking after inflation in the UK unexpectedly remained stuck at 8.7% in May, adding to the pressure on households suffering a surge in mortgage costs.

The Office for National Statistics reported that good inflation slowed, but services inflation accelerated at a faster pace in May.

Core inflation, closely watched by the BoE jumped to a 31-year high.

The money markets are now predicting that UK interest rates will have hit 6% by around the end of 2023.

The Bank sets UK interest rates tomorrow – a hike is nailed-on, with some economists suggesting it could lift borrowing costs by half-a-percent, to 5%. The majority expect a smaller, quarter-point, increase to 4.75%.

Mortgage holders are being hit by higher rates – Moneyfacts reported that the average two-year fixed-term mortgage now costs 6.15%, up from 6.07% on Tuesday.

More than 1 million households across Britain are expected to lose at least 20% of their disposable incomes thanks to the surge in mortgage costs expected before the next election, the Institute for Fiscal Studies has warned.

Tenants are also suffering, with rents rising at the fastest pace for 7 years.

And the boss of Berkeley Group has said the property market will remain “choppy” until interest rates settle, as the housebuilder forecast a 20% drop in sales this year.

In other news….

UK government debt has surpassed GDP for first time in 62 years

Some of the UK’s best known retailers including WH Smith, Marks & Spencer, Argos and LloydsPharmacy are among more than 200 companies collectively fined £7m for failing to pay the legal minimum wage.

The TransPennine Express train service has got “worse rather than better” since transferring to the state-owned operator of last resort (OLR), according to the rail minister, Huw Merriman.

Matt Moulding, the founder and chief executive of the online retail platform THG, has finally given up his “golden” share allowing him to block any attempt to takeover the company.

Our Politics Liveblog are covering the Westminster reaction to today’s inflationo report, here:

With UK inflation so sticky, Rishi Sunak’s pledge to halve the UK’s rate of inflation is looking trickier than when he made it.

My colleague Phillip Inman explains:

May’s data shows that most of the price rises are in areas of discretionary spending, like holidays, recreation and entertainment.

Britons have always demanded foreign holidays. And after three years of uncertainty and long periods of restrictions on travel, the sale of flights has rocketed. No one seems to mind that the airlines are hoping to recover some of their pandemic losses with much higher ticket prices.

Sunak could still score a victory. He has six months to go. Some of the biggest increases in energy and food prices happened last summer and these will not be repeated over the coming few months, which should mean inflation drops to 5% quite quickly.

Still, he thought it was going to be his easiest win and now it looks like being a Johnsonian gamble. He seems to have misread the UK economy, or at least the capacity of businesses to keep increasing prices without much justification. In that, he is not alone.

Our Money editor, Hilary Osborne, has examined why the UK property market is so reliant on short-term fixed mortgages, not the long-dates type popular in other countries.

She explains:

As well as borrowers’ desire for the cheapest deal possible, one industry source suggests that brokers have a role in keeping the market short-termist as they receive fees when a new deal is taken out, and have no incentive to tie in their customers for the long haul.

Concern about keeping options open also seems to be a factor. Although many mortgage lenders now allow overpayments and for customers to “port” their loan if they move home, borrowers think short term equals flexibility.

Neal Hudson, a UK housing market analyst at the consultancy BuiltPlace, said people might have been put off paying more for a longer-term deal because of expectations that prices would continue to rise and rates would continue to go down. He said: “The general experience over the past 40 years has been that – there may have been some short-term pain but in the medium term people have always ended up all right.

“The market has clearly bottomed out now, so will we see a change? Maybe a long-term fix does become more appealing.”

More here:

Housing analyst Neal Hudson has crunched the numbers on how house prices could fall as mortgage rates rise higher:

NatWest is raising the interest rates on some mortgage tomorrow, as lenders continue to ratchet up borrowing costs.

NatWest has told brokers it is lifting the rate on selected two-and five year fixed-rate deals by 30 basis points (or 0.3 of a percentage point).

This will cover home purchase mortgages, remortgaging products, and those aimed at first-time buyers.

This follows today’s market reaction to May’s inflation report, with UK interest rates expected to hit 6% at the turn of the year.

PA Media have written a handy explainer about the UK’s inflation problem:

Q: What is inflation?

Inflation is the term used for the rate at which prices increase over time.

If the price of something rises from £10 to £11 over a year, then that would represent annual inflation of 10%.

Every month, the ONS reports the annual increases on a raft of items and services, including everything from computer games to a loaf bread.

Q: Why is it currently so high?

In May inflation struck 8.7%, as it continues to slow from the 11.1% peak it hit late last year.

Prices rocketed last year after the Russian invasion of Ukraine in late February 2022 caused the price of energy to shoot higher, adding to pressure from supply disruption.

It contributed to higher costs for firms making products or offering services, while labour costs also started to rise.

Since then, higher food and drink prices are a key reason why inflation has failed to fall as fast as hoped.

Olive oil, eggs and cheese are among items to see the sharpest increases over the past year.

Q: Why has there been a negative response to flat inflation for last month?

Firstly, it is important to highlight that flat inflation does not mean that prices have stayed the same. It means that the rate of price increases is the same as it was in the previous month.

In April, the rate of inflation dropped to 8.7% from 10.1% in March. Economists and politicians had hoped that this rate would continue to drop, with expectations it would fall to 8.4% for last month.

Inflation flatlining at 8.7% for May could indicate that it will take longer than hoped for inflation to drop to more normal levels, keeping pressure on household budgets.

Q: What does it mean for interest rates?

The Bank of England has a target to try to get the rate of inflation to around 2%.

In order to drag inflation down quickly, the most commonly used policy tool used by the central bank is increasing the base interest rate.

Increases to interest rates – which currently sit at a 14-year high of 4.5% – are designed to reduce demand from people to borrow money, because of the higher charges they will face, and encourage people to save their cash.

It is hoped that lower spending and increased saving will encourage firms to reduce prices to keep customers purchasing products or services, helping to reduce the rate of inflation.

How will this affect my mortgage?

Some variable rate mortgage deals directly track the Bank of England base interest rate and they automatically increase in line with the base rate.

Borrowers can also end up on a standard variable rate (SVR) when their initial mortgage deal ends. The SVR is set by lenders individually but it can often roughly follow movements in the base rate.

The bulk of mortgaged UK homeowners tend to take out fixed-rate deals.

Swap rates underpin the pricing of fixed-rate mortgages and these have been rising amid expectations around inflation, as it has turned out to be more “sticky” than some had expected.

Fixed-rate mortgage rates have been on an upwards march in recent days, with the average two-year fixed-rate residential mortgage now sitting at around 6%.

Q: When will we see respite from the cost-of-living crisis?

Despite the latest setback, inflation is still widely expected to continue to fall.

Last month, the Bank of England predicted that inflation would fall to 5.1% in the fourth quarter of 2023.

Q: What does it mean for the Government’s pledge to halve inflation?

The Government pledged to halve inflation annually from a rate of 10.7% at the start of the year, as part of five promises by Rishi Sunak’s Government.

At the time, economists had forecast inflation was on track to drop to around 2.9% by the last quarter of 2023, but have reduced this to 5.1%, raising concerns the pledge could be at risk.

Chancellor Jeremy Hunt said in response that the target was “still absolutely deliverable” but stressed that there is still a long way to go to achieve this.

Jim Reid, market strategist at Deutsche Bank, reckons we live in a financial era where “inflation is always with us”, even if there are periods where it can be more dormant for several years.

In a new research note today, Reid argues that the main cause is “fiat money” – cash directly printed and issued by governments that isn’t pegged to an underlying commodity.

Since the world effectively moved to fiat money in 1971, there is no country in the world that has averaged inflation below 2%. It is too easy to create money and run deficits, and the temptation to do that rather than take harder decisions will always be there when the inevitable and fairly regular economic and financial shocks hit.

The UK and the US are a bit more likely to have this bias than the EU due to their respective central bank mandates and stricter deficit rules, but the latter is not immune.

So even if inflation eventually mean reverts to the central bank targets this cycle, the probabilities are high that it will average above it for the rest of your careers unless you think we have a great reset at some point where markets refuse to buy any more government bonds. Even at that point central banks may simply take up even more slack.

Core inflation in the UK could remain higher than in the US or euro area until late next year, Capital Economics fears.

Ruth Gregory, their deputy chief UK economist, explains:

Inflation in the UK has stayed higher than elsewhere as the UK has endured the worst of both worlds – a big energy shock (like the euro-zone) and labour shortages (even worse than the US).

Admittedly, the upward influence of the energy supply shock is fading.

But the tighter labour market will probably mean that UK core inflation stays higher than in the US and the euro-zone until late-2024.

America’s central bank chief has warned that interest rates in the US will head higher.

Earlier this month, the Federal Reserve paused (or possibly skipped) an interest rate, by voting to leave its benchmark rate on hold.

But today, Jerome Powell told Congress that most policymakers on the Federal Reserve’s FOMC committee expect to push rates higher at future meetings.

In prepared remarks for the House Financial Services Committee, Powell says:

“Nearly all FOMC participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year.

Powell also says the Fed is “squarely focused” on its dual mandate to promote maximum employment and stable prices, adding":

My colleagues and I understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2 percent goal.

Price stability is the responsibility of the Federal Reserve, and without it, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.

The pound has lost ground today, reflecting concerns that higher interest rates will trigger a recession.

Sterling has lost half a cent against the US dollar, dropping below $1.27 for the first time since last Thursday.

That suggests that the possibility of higher borrowing costs, and possibly a bumper half-point hike on Thursday, is worrying traders.

As Kit Juckes, chief global FX strategist at Société Générale, explains:

The risk of a 50bp rate hike tomorrow has increased, the risk of a deeper slowdown has increased even more.

Today’s upward inflation surprise increases the pressure on the Bank of England and raises the risk of a return to an oversized hike at tomorrow’s meeting, say the Markets 360 team at BNP Paribas.

But, their base case is for a quarter-point increase, accompanied by “more decisive language” in the minutes of this month’s meeting, or other post-meeting communications.

They predict interest rates will peak at 5.5%, a whole percentage point above today’s levels:

The bottom line, regardless of the size of tomorrow’s move, is that the MPC has a lot more work to do to bring underlying inflation under control – we stick to our terminal rate call of 5.50%.

Downing Street has insisted Rishi Sunak is still sticking with his pledge to halve inflation by the end of the year, despite inflation remaining stickily high.

The Prime Minister’s official spokesman told reporters:

“That remains the target.”

Asked if they are on track to fulfil the promise, the spokesman said the government was (despite inflation coming in above target for the last few months):

“Yes. Despite some of the coverage at the time (of the announcement of the pledge) this was never something that was straightforward.

“It was rightly an ambitious target that we remain committed to and it can only be achieved with fiscal discipline.”

Here are more details from the IFS’s new report into the financial hit from rising mortgage payments, which warns that 1.4m mortgage holders will lose 20% of their disposable income to rising borrowing costs.

15h ago22.01 AEST

IFS: Interest rate hikes could cost 1.4m people a fifth of their disposable income

Richard Partington

Newsflash: Millions of households across Britain are expected to lose at least 20% of their disposable incomes thanks to the surge in mortgage costs expected before the next election, the UK’s leading economics thinktank has warned.

Sounding the alarm as mortgage costs reach the highest levels since the 2008 financial crisis, the Institute for Fiscal Studies said that almost 1.4m mortgage holders would see at least a fifth of their disposable income erased.

It warned the heaviest blow was reserved for those under the age of 40 with larger mortgages, with the biggest financial hit for households in London and the south east of England where property prices are typically higher than the national average.

The biggest rise is for those in their 30s, for whom payments will jump by £360 per month, or 11% of disposable income.

On average, mortgage holders will see their mortgage payments rise by £280 per month – equivalent to 8.3% of their disposable income (i.e. income after mortgage payments).

Tom Wernham, a Research Economist at IFS, explains that many borrowers face a serious shock when they remortgage.

“Many families bought homes – often with sizable mortgages – when interest rates were very low. As people’s fixed term offers come to an end they are going to be exposed to much higher interest rates.

For many, the increase in monthly repayments is going to come as a serious shock – on average it will be equivalent to seeing their disposable income fall by around 8.3%. And for 1.4 million mortgage holders – half of whom are under 40 – mortgage payments are set to rise by an eyewatering 20% of disposable income or more.

Given the cost of living pressures people are already facing due to high food and energy price inflation, these significant increases in mortgage costs could not come at a worse time.”

Back in parliament, Rishi Sunak has said it is vitally important that savers are treated fairly, following concerns that savings rates have not risen in line with borrowing costs.

Chancellor Jeremy Hunt will discuss this matter when he meets with UK banks on Friday, the PM added.

Martin Lewis of MoneySavingExpert.com says he was called to an “urgent private meeting” with Jeremy Hunt today to discuss mortgages.

Lewis says he explained that banks should offer “proper forbearance” to struggling mortgage-holders, and not ramp up their profit margins:

Duncan Robinson of The Economist questions which of the pair are actually in control….