Newsletter: February 2023
As ever, I am going to provide you with our view of the economic environment and how this might affect your investments. Of course, it won’t be lost on you that there are many workforce strikes, political scandals, high prices and a feeling that there’s nothing but poor news around the world.
You don’t need me to tell you we have been facing some challenges this last financial year with increased consumer demand driving up higher prices across all goods and services, around all of the world. That is, high inflation!
The central bankers and Governments of the world have in the main, just two weapons to address the issue of high inflation we face at the moment and these are fairly brutal; higher interest rates and more taxation!
Inflation eats away at the value of the pound in your pocket. One day a loaf of bread might cost £1 and by the end of the year it costs £1.30, so unless you have increased your income over that period, you will feel worse off. A fall in inflation and an increase in wages closes the gap.
Governments and Central bankers have tried to reduce inflation by causing us to think twice about whether we can or should buy stuff. If you wanted to buy a new car on finance (assuming you can get one built!), then having a higher interest rate could make you think more about the monthly payments you would have to make to the finance company. You might not want to pay a lot more interest and, therefore, choose to keep your current car for a little while longer. Replicate this across the wider economy and car sales fall, inflation then falls too.
Similarly, if you want to increase your mortgage, the higher interest rates on that borrowing might mean you decide not to borrow or borrow less. The higher interest rates and, therefore, monthly costs, takes money from your pocket. This reduces your demand for other goods and services, in turn, reducing inflation.
Taxation is the other weapon against inflation. The theory is, that if you take money out of people’s pockets, then they have less to spend elsewhere. This reduces demand and over time, inflation. Our government here in the UK, decided to raise some taxes by introducing ‘stealth’ measures. This is where they freeze allowances such as the tax-free personal income tax allowance, which means as your income grows, you pay more tax.
Recent data across the western world shows a slowdown in the pace of inflation and we still have positive economic growth. In the US in particular, inflation has fallen below their bank interest rate which has been received very well by the markets. This has come about by them raising their central bank interest rates quickly, to a much higher level than seen in recent times. It is expected these interest rates will reverse over the rest of this year.
It is expected that towards the end of 2023, we will all see a decline in the rate of inflation. This doesn’t mean prices in the shops or at the Petrol station will come down, but more that they won’t increase as fast going forward. This is good news as this creates the opportunity for each of us to enjoy any surplus we might have in our disposable incomes.
It is also expected that interest rates will start to come down by the end of 2023. The cost of borrowing will reduce, mortgages will become cheaper and government borrowing falls too. I’m sure most of you remember when interest rates hovered much higher than they are now, thankfully, we won’t see anything like those levels now, but we might see a ‘normal’ rate of interest in the region of 3% by the end of the year.
Of course, higher interest rates and taxation would ordinarily hurt those unable to meet those higher costs. There are about 100,000 people coming out of fixed rate mortgages each month here in the UK. There was a lot of concern about these homeowners not being able to meet their higher monthly mortgage payments, however, there is little evidence the mortgage world has caused any major issues and most borrowers seem equipped to cope. This may be because they have previously saved a lot of cash during lockdown and have spare to cover their increased mortgage bills.
Meanwhile, employment remains strong everywhere. There are also a record number of vacancies here in the UK and it seems to be the case that when individuals face redundancy they find work straight away. It also seems that even as we face a short recession, unemployment isn’t expected to rise significantly. The high number of vacancies will most likely be cancelled and recruitment by firms falls off.
China has decided to cancel their zero Covid policy and this too has been received well by the markets. The world’s second largest economy makes the stuff we want to buy, they order the things we want to sell and this boosts economic activity. The downside to China opening up again is that they will most likely increase their pollution into the atmosphere and as nations strive to reduce the impacts of climate change, China might actually be on a road to expansion and, therefore, emit more harmful C02.
As has been the case over the past few months, the UK is somewhat trailing economic trends elsewhere in the western world, and consumers and private investors like you, can be excused for not sharing in the more upbeat sentiment elsewhere. However, the more positive economic picture emerging in some of the most important markets for UK multinational companies, bodes well. The UK government clearly has a substantial to‑do‑list in its ‘in-tray’ for trading opportunities to materialise. So, the next stage of post-Brexit trade (yes I know you probably thought Brexit was done!) will be a key area to watch here, beyond the inflation, job market and company earnings elsewhere.
The markets are, however, balancing their views against other data being published such as consumer and business confidence. There are some who warn that the global economy could yet stall as the effects of interest rate rises and higher inflation haven’t yet fully emerged. We shall have to wait and see how everything pans out.
So, in summary, there is the appearance of a ‘soft-landing’ in that central banks have managed to reduce inflation without causing a worldwide recession. This doesn’t mean everyone in society is able to cope with higher food and energy prices, but hopefully the pain for them will be short lived.
With regards investment portfolios, you might be forgiven for expecting a muted year in terms of returns, but a more positive outlook may be around the corner.