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Our views 27 June 2022

JP’s Journal: On my bike

5 min read

The Triple lock is back. To remind: basic state pensions are linked to the higher of Consumer Price Index (CPI) inflation, average earnings or 2.5%. Now, I am no politician but I can see bad outcomes from this.

Just watching a government minister trying to criticise rail workers for rejecting their 3% pay offer whilst defending increases for non-workers, which may well exceed 10% based on September 2022 CPI, was embarrassing. A summer of discontent certainly lies ahead.

Let’s face it the UK’s transport infrastructure is pretty poor: airports with too few staff; expensive trains that may not turn up (Avanti being a good case in point); congested roads sometimes with endless restrictions for no apparent reason; buses that a snail can overtake; bike lanes that give out suddenly at the worse point. Big projects like HS2 may reap long-term returns, but in a typically British way we divert resources away from areas that could deliver more immediate and widespread benefits (northern rail improvements as an example). 

Yet the railways do need to modernise. Despite the high cost of rail travel, expenditure exceeds income. You don’t need to be Mr Micawber to sense trouble. And this is despite government funding of £17bn. Privatisation was a botched job but anyone who can remember British Rail will not wish for its return. We have to find a more joined up way to run our trains that retains a profit incentive to encourage investment and innovation and that allows for changing patterns of work and leisure. Fridays are now the busiest days on the rail network as work and leisure users get on board. In the meantime, I had some great cycles into work last week. Lovely early morning temperatures and some nice tailwind breezes going home.

Under pressure

Back to markets. I have flagged up in recent weeks my growing concern about the global economy. I was already dubious about the “pent-up savings” argument that would see consumers unleash spending as we came out of Covid restrictions. Now we are faced with the wealth effects of falling bond, equities and crypto. The last piece missing is housing which could soon join the list of casualties. I think there could be reasons why it may be different this time – but I would not bet on it. Which makes the Bank of England’s (BoE) decision to ease affordability rules on mortgages even more mystifying. OK, it may not have any meaningful impact given other policy constraints, but it is a signal – and an unwise one at that. I don’t want to sound too critical – but in my view the BoE have not got a lot right recently.

A key question is whether a recession will be mild. Another is whether any slowdown will be sufficient to put into reverse energy, food, and wage cost pressures. My opinion is that a recession will put into reverse these trends. This is based on my view that any recession is unlikely to be mild (a few quarters of slightly negative growth). Economies across the globe are intertwined and some parts have become over-dependent on cheap finance. A combination of elevated input costs, higher funding charges and lower top line revenue is not the basis of a soft landing.

Inflation still the headline

The latest UK CPI showed inflation at 9.1% with RPI (Retail Price Index) at 11.7%. No wonder the government is trying to get index linked gilts (RPI referenced) anchored to a different measure and no wonder some pension funds are pushing back. Over to the judges on that one.

The main driver of UK inflation in May was food, but only three of the twelve main components of the CPI basket showed a downward contribution. With the labour market pretty tight we can expect more UK rate rises. Surprisingly, perhaps, interest rate expectations fell back last week. A sharp rally in bond markets saw 10-year yields fall 10bps in the US and 20bps in the UK whilst the rally in German rates saw 10-year yields fall to 1.43%, a decline of 23bps on the week. The moves at the short end of the market knocked 50bps off UK rate levels on a 12-month horizon. Nevertheless, markets still see even more UK rate hikes over the next 12 months – taking UK interest rates to 3%. There are clear signs that the UK consumer is coming under pressure with the latest Retail Sales figures continuing the downward trend seen since in recent months. June UK consumer confidence fell a touch further which suggest more downward pressure on spending.

Sterling investment grade credit spreads were a touch wider on the week whilst the move in high yield was more pronounced with my favoured measure now above 6%. New issuance has fallen sharply but there are still some new deals coming – and with attractive yield premia. Rentokil is a case in point, being sold last week at 255bps above gilt yields.

To end on a different note. The move up in bond yields and higher interest rates has not yet been reflected in National Savings rates. As the government berates petrol retailers for not passing on the fuel duty cut, they should perhaps look closer to home.


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