The week ahead 26 June 2023 - Rising core inflation leads to bigger than expected rate rise

What to watch out for in the UK economy and property market this week.

A surprise increase in UK core inflation, from 6.8% in April to 7.1% in May, prompted the Bank of England to hike the base rate by 50 bps last week; double the 25 bps that analysts had been expecting just a few days before. Forecasts for interest rates have been revised upwards, with Oxford Economics now expecting the base rate to peak at 5.75%, up from 5.00% previously. The one-year swap rate reached 6.1% on Thursday, up from 5.8% a week ago and 5.0% in early May. The 10-yr Gilt yield stood at 4.35%, which is down slightly on a week earlier. This reflects growing concerns that the level of interest rates needed to bring down core inflation might tip the economy into recession. Fears of a downturn usually cause investors to buy Gilts which are seen as a safe haven asset. All this increases the likelihood that property yields may rise.

This round of inflation began with energy prices, but has now migrated to other goods and also services. Because high energy prices lasted so long, people’s inflation expectations have lifted. Previously, firms and workers generally assumed inflation in the future would be around 2%, and that set their expectations for price rises and pay growth. The risk now is that if everyone believes the new normal is 8%, then all price increases and pay demands will settle at 8%, creating a fait accompli. So, the central banks are returning to interest rate hikes, although concern is building on the effects of so many rate increases in such a short space of time on the disposable income of mortgage holders. For this reason, we suspect central banks may look to use other tools (alongside rate increases) to fight inflation, such as quantitative tightening, which is the opposite of quantitative easing. Our full analysis of the Bank of England decision can be found here.

This week sees the release of the Nationwide UK house price index, and given the backdrop of rising interest rates, it looks likely another fall will be reported. With concerns re-emerging on a recession and inflation still high, house prices will probably decline for several months to come. Also out this week is German inflation data, and we expect to see rising services prices pushing up core inflation.

Things to watch for this week

Thursday 29th June

Germany HICP inflation, June

Previous: 6.3%
Forecast: 6.7%

We believe that rising services prices have pushed up headline and core inflation in June, reversing some of the sharp drop in prices reported in May.

Euro Area Economic Sentiment, June

Previous: 96.5
Forecast: 96.0

With interest rates rising and inflation proving to be sticky, our forecast is for business sentiment to have weakened in June.

Friday 30th June

Nationwide House Price Index, June

Previous: -3.4%
Forecast: -4.3%

Given mortgage debt is getting more expensive, with the average two-year fixed rate deal reaching 6.0%, we expect to see another fall in house prices reported.