October 2018

October 2018

Commentary

This time of year brings wistful feelings as one of our greatest British summers gives way to decidedly chilly and dark mornings. It is also a time when I, perhaps like many other men of a similar age, feel myself morphing into my own father, responding pitilessly to various central-heating-related complaints with “go and put a jumper on” or “you must be joking, the clocks haven’t gone back yet”. What was it Theresa May said about austerity coming to an end…?

Our housing clients will have been watching the party conference season with interest. Not perhaps in anticipation of Theresa May busting some moves or Jeremy Corbyn announcing a clear policy on Brexit, but in hope of some positive announcements about housing. The main point of interest on this front was Theresa May’s announcement that she would remove the cap on HRA borrowing. We will see in due course whether there are strings attached, which we know from past experience is a risk in this area, but this seems so far to be a genuine good news story.

Local authorities with the appetite and capacity to innovate in terms of housing delivery have been able to for a long time so reality may not match some of the rhetoric, but it is still good in my view because, if nothing else, it raises the political stakes should the government fail to deliver more homes. It is particularly interesting in terms of the mood around “austerity” – a government strongly committed to austerity would surely be more likely to clamp down on town halls using public-sector leverage to buy shopping centres and the like than to lift the HRA cap. Admittedly, what it tells us about the long-term strategy around public debt, interest rates and inflation is less clear…

We are also now moving into the business end of the Brexit negotiations. The campaign for a second referendum may or may not be gathering pace depending on whom you listen to, the Conservative Party is as divided as ever and Labour much the same, and who will ever forget the excitement of the endless debates over the merits of Chequers vs. WTO terms vs. a Canada-style agreement (choose your number of pluses if you understand what any of the pluses represent). The parliamentary arithmetic makes the passage of any deal through the Commons a treacherous one. In addition, with the EU having roundly rejected the Chequers plan and an impasse over which side blinks on the Irish border question, even getting an agreed deal to put to the Commons is looking like a stretch.

But while the chances of “no deal” have increased in recent months, I’m going to make a clear (if foolhardy) prediction here, that realpolitik will prevail and an 11th hour deal will be cobbled together, with drama and theatre and a certain amount of holding of noses, but a deal nonetheless. There is too much at stake for this not to happen. Another perhaps less confident prediction is that the passage through the Commons may be easier than some are predicting with enough MPs variously blinking, putting aside their personal wishes, and potentially defying whips to vote for “the deal” as opposed to the constitutional chaos that would ensue in the event of Parliament rejecting it.

There, I’ve said it and now point all readers to the disclaimer at the end of this document in which we expressly disclaim all liabilities in relation to the contents of this report!

What that leaves, apart from a jittery period until April 2019, in which we may see heightened volatility in markets and a challenging environment for making decisions, is the question of how detailed “the deal” is and whether we go into April with a relatively clear head or still facing years of uncertainty about the practicalities of our relationship with the EU. We shall see.

Should talks break down there is a risk of a UK sovereign downgrade which would affect HA credit ratings and investor sentiment. Even if things do progress in line with the above scenario, while it would be extreme for markets to close to strong investment-grade borrowers between now and Brexit, investors are likely to lack conviction which may put borrowers on the back foot. Clearly in that context it is better not to be a forced issuer and this is a good example of the benefits of carrying spare liquidity. For those borrowers seeking funding over the coming six months, we would recommend that options are kept open with the ability to switch to a Plan B should the need arise.

Financial Markets and Economics Overview

As the November deadline for a Brexit deal edges closer, the lenses have focused closely onto the negotiations and outcomes in September. Most notably this month, the Chequers Plan was dismissed by EU leaders and negotiators at the Salzburg summit, meaning that the Brexit plan would have to be substantially revised. Inevitably, this caused an immediate reaction of uncertainty for the UK, which was reflected by a 1.5% weakening in sterling. Prior to the Salzburg summit, sterling was strengthening as markets remained optimistic for a deal to still come through by March 2019.

Gilt yields have increased since the end of August due to the political turbulence, as investors sell government bonds due to uncertainties surrounding the outcome of the UK. From the end of August to the end of September, both the 10-year and 30-year gilt increased by 14bps. However, this increase appeared to be relatively modest when compared against other leading capital markets that were heavily affected by political related events such as in Italy. Again, this could be attributed to the fact that markets continued to remain calm about Brexit, as it is expected that some form of agreement that prevents the UK from crashing out to eventually be reached.

UK manufacturing PMI for September provided a more positive outlook for the UK economy, as it increased to 53.8 from 53 in September. However, there was an unexpected surprise in UK CPI for August, as it jumped to 2.7% from 2.5% in July. There were large increases in the average price of clothing and transport. Petrol prices also climbed 1.4% between July and August but this was lower than the previous year’s increase of 1.8%. Whilst August’s CPI could be seen as a one off surprise as the increase came mostly from prices of goods and services, which fluctuate month on month, it raises the question for the Bank of England on whether the economy can grow without accelerating inflation in the near-term.

In the UK, annual house price growth was steady at 2%, with prices up 0.3% during the month, according to the Nationwide HPI. Nationwide also released its Q3 figures, which showed a quarterly increase of 0.7%.

Outside of Europe, the US increased interest rates by 25bps to 2.25%, which was the third increase this year. As per current expectations, the Fed also pointed to another rate hike later this year, three more hikes in 2019 and one more in 2020. Its tightening monetary policy continues as labour markets remain strong.

The US, Mexico and Canada finally reached a trilateral trade agreement. This provided a moment of tranquillity, as the US-China trade war continued in full force in September. The US tariff on $200bn of Chinese imports took effect in September and China has retaliated by announcing additional tariffs of £60bn in addition to the already existent £50bn tariff on US imports. In light of this retaliation, the US have threatened China with an additional $267bn of tariffs on Chinese products.

Interest Rates

Inflation

Capital Markets

Bank Credit