Optimism is setting in - is it warranted?
Making sense of the latest trends in property and economics from around the globe.
5 minutes to read
People often say that sentiment is fickle, but narratives of optimism or negativity get harder to dislodge the longer they are left to run.
Western central banks are struggling to convince investors that inflation remains a threat, as we've touched on in several notes recently. The S&P 500, the index tracking the largest listed companies in the US, climbed 8.9% in November, its best November since 1980 if you exclude the pandemic-fueled rebound of 2020. Global stocks just recorded their best month in three years.
The message from markets is clear: central banks are done hiking and all that's left to debate is when the first rate cuts will arrive. Holders of this view were given another boost yesterday by Eurozone figures showing the annual rate of inflation had dropped to 2.4% in November.
Why then do the heads of central banks insist on taking what appears to be an overly negative view? Bank of England Governor Andrew Bailey appears particularly keen to communicate that the UK outlook is the worst he's seen in his career - comments that "show a misunderstanding of the (unofficial) communications responsibility of a Governor in framing economic decisions," says Simon French, chief economist and head of research at Panmure Gordon. "Growth, productivity & profit requires optimism, and CB leaders have an outsized role in setting that mood."
Premature celebrations
A new paper from the International Monetary Fund offers clues as to why Mr Bailey and his peers are so keen to spoil the party. Researchers Anil Ari and Lev Ratnovski draw on recent IMF research of more than 100 inflation shocks since the 1970s that offer two reasons for caution.
Firstly, inflation is generally persistent - 40% of countries in the IMF study failed to resolve inflation shocks even after five years. It took the remaining 60% an average of three years to return inflation to pre-shock rates.
Secondly, and perhaps most importantly: countries have historically celebrated victory over inflation and loosened monetary policy prematurely in response to an initial easing of price pressures. Denmark, France, Greece, and the United States were among nearly 30 countries in the IMF's sample to loosen policy prematurely after the 1973 oil-price shock, for example.
"In fact, almost all countries in our analysis (90 percent) that failed to resolve inflation saw price growth slow sharply in the first few years after an initial shock, only to accelerate again or become stuck at a faster pace," the paper states. "Today’s policymakers must not repeat their predecessors’ mistakes. Central bankers are right to warn that the inflation fight is far from over, even as recent readings show a welcome moderation in price pressures."
The era of falling rates
Interest rates that are higher for longer would weigh on real estate valuations and transaction activity, but permanently higher rates present a different threat entirely.
The onset of rate hikes in late 2021/early 2022 set off a debate among economists as to whether something enduring had shifted in the global economy. Could it be the case that the period of falling rates that characterised the post-Global Financial Crisis boom in property values was an anomaly?
Bank of England researchers attempted to tackle that question yesterday. They take the view that there are two powerful forces exerting long-term downward pressure on global interest rates. Firstly, the world's aging population means that people reaching retirement can now look forward to living another twenty years or so - a figure that will rise to almost 30 years for coming generations. That will require a massive surge in savings, which banks will lend to firms chasing diminishing returns, weighing on market interest rates - you can read a fuller explanation here.
Secondly, slower productivity growth means firms have lower expected returns on their investments, which reduces the demand for capital - again, weighing on rates. This factor feels a little shakier, given what little we know about how Artificial Intelligence could impact productivity in the coming years. Nevertheless, the researchers conclude that, "without a reversal in these trends, or new forces emerging to offset them," long-run global interest rates will remain low. Here’s hoping.
UK house prices
The recovery in UK house prices continued in November, Nationwide said this morning. Values rose 0.2% during the month, a third successive monthly increase that trims the annual decline to -2%.
“There has been a significant change in market expectations for the future path of Bank Rate in recent months which, if sustained, could provide much needed support for housing market activity," says the lender's chief economist Robert Gardner - happily ignoring the Bank’s advice (see above).
Indeed, separate figures published by the Bank of England this week showed that mortgage approvals for house purchase, a good barometer for future activity, rose to 47,400 in October, up from 43,700 in September (see chart). Here is Tom Bill, Knight Frank's head of UK residential research:
“If we are not at the bottom of the current slowdown in the UK housing market, we must be close. Price indices are potentially more volatile due to low transaction numbers but sentiment has improved in recent weeks as the worst of the economic data moves behind us. Inflation is below 5%, the best five-year fixed-rate mortgage has fallen to less than 4.5% this week and speculation is focussed on the timing of the next rate cut not the size of the next rise. After a flat autumn, the UK housing market should see a spring bounce in 2024 provided a general election is not called in the first half of next year.”
In other news...
Scotland’s rent controls pile pressure on landlords (FT), Labour rules out scrapping inheritance tax relief for farmland (FT), and finally, the UAE plans to start a $30bn climate fund with Blackrock, Brookfield (Bloomberg).