Trump vs Markets: Round 2
Making sense of the latest trends in property and economics from around the globe
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Liam Bailey, Knight Frank
4 minutes to read
UK inflation surged to 3.5% during the year to April, up from 2.6% last month, after the energy regulator lifted the price cap at the start of the month.
This was widely anticipated – analysts had expected a print as high as 3.6% – but some of the underlying data was also pretty hot, which may further dampen sentiment after this month's split decision at the Bank of England: five Monetary Policy Committee (MPC) members voted for a 25bps cut to 4.25% and the other four members were split evenly between holding rates steady and executing a 50pbs cut to 4.00%.
This looks problematic: the annual rate of core inflation, which excludes volatile items like energy and food, increased to 3.8%, from 3.4%. Services prices rose to 5.4%, from 4.7%, likely as a result of the minimum-wage increase at the beginning of April.
Squeeze it out
That said, this is probably fine. Forward-looking indicators of pay growth are moderating and, as the MPC has pointed out, slack is emerging in the labour market, but the data does leave open the possibility of a structural shift in wage and price setting behaviour, which is what worries the more hawkish members of MPC.
The Bank's former chief economist Huw Pill, one of the MPC members who voted for a hold, yesterday expressed his concern that 'greater real income resistance' among entrepreneurs and earners may have altered the disinflation process in some permanent way – these "structural changes...may require a more prolonged maintenance of policy restriction to ‘squeeze out’ the inflation arising from intrinsic persistence," he added. Still, he characterised his vote as a "‘skip’ within a continuing withdrawal of monetary policy restriction, rather than a halt to the process of withdrawal."
Other members of the MPC are likely to coalesce around this view without swift progress on the underlying sources of inflation. As things stand, markets expect the Bank to deliver another two quarter-point rate cuts before the year is out, taking the base rate to 3.75%, but it's going to be slim pickings from that point onwards. Consultancy Capital Economics reckons the base rate will stand at 3.50% at the end of 2027.
Nevertheless, competition in the mortgage market has continued to drive the best rates lower. All the major lenders still have products available below 4%. As of yesterday, the best two-year fixed rate products at 60% loan-to-value sat as low as 3.80%. The corresponding five-year rate was 3.83%.
$36 trillion
At the turn of the year, while preparing The Wealth Report 2025, we asked the smartest people we could find what might go wrong during the coming years - what has the highest chance of derailing the economy?
Fiscal ill-discipline was among the top answers. While the private sector has historically been perceived as the bigger risk to financial stability, across G7 economies government debt servicing costs are increasing, and debt loads in many advanced economies stand at 100% of GDP or more. The brief premiership of Liz Truss, and its aftermath, illustrated how markets can punish governments guilty of fiscal ill-discipline – and the risks are rising rapidly.
No candidate is more vulnerable than the US, where national debt exceeded US$36 trillion in January, surpassing its GDP and marking an historic high. On Friday, the credit rating agency Moody's downgraded the US’s triple A sovereign credit rating. Then on Sunday evening, a congressional budget committee approved a tax bill from the Trump administration that could push debt to about 117% of the economy’s size by 2034, higher than the post-war 1945 record (see chart courtesy of the NYT).
Heading for the rocks
The 30-year Treasury yield briefly surpassed 5% on Monday before easing back, but traders are still piling into bets that long-term Treasury yields will surge further, Bloomberg reports. Among the more worrying aspects of the bond sell-off was the corresponding size of falls in the dollar - a sign that overseas investors were offloading US assets, wrote the FT's Aiden Reiter.
“The bond market is in a delicate state, and the risk of a Liz Truss moment is a non-trivial possibility in current conditions," analysts from BNP Paribas said in a note to clients.
Should Treasury yields behave as traders expect, mortgage rates will rise even further, worsening affordability and suppressing what is already weak purchasing activity. But really, that's of secondary concern to a bond market scenario that Ray Dalio, billionaire founder of hedge fund Bridgewater Associates, likened to "being on a boat heading for the rocks and having those running the ship arguing over which way to turn.”
"I don’t care whether they turn left or right as much as I care that they turn to get the ship back on course,” he told the FT on Monday.
In other news...
Kate Everett-Allen on the resilience of the prime Paris residential market. Plus, Tom Bill on why high supply is keeping UK house price growth in check.
Elsewhere - LondonMetric on a path to 'dividend aristocracy' (Company Results), and finally Landsec posts rental income growth of 5% (Company Results).