Inflation was again dominating headlines last week. On Wednesday UK CPI data for April showed annual inflation at 1.5%, in line with expectations. However, RPI at 2.9% was significantly above consensus; this was the largest gap between the two indices since November 2010.
So what drove this divergence? First, the different make-up of the indices is estimated to account for 0.8%, with RPI having higher weightings in service sectors more exposed to Covid and, therefore, the bounce back we are now seeing. Second, house price inflation (in fact depreciation costs which proxy house prices) is embedded in the RPI index. In April this component rose by 1.4% over March, far greater than expected.
On the same day, the UK Land Registry released its House Price Index. This showed that house prices had risen 10.2% over the year. For a change London is a laggard, barely registering any increase, whilst Wales saw the biggest rise. I have written about house prices and how, in my opinion, the collapse in real yields has been an important driver of the appreciation seen over thirty years. But successive governments have also played a part.
We have an unhealthy relationship with housing in the UK – an obsession that has had a distorting impact on society and our economy. Successive governments have tried to make it easier to get on the housing ladder – apparently oblivious to the blindingly obvious: subsidy will be reflected in higher prices. The beneficiaries of these subsidies primarily are not first-time buyers, who would really benefit from the removal of props and a true price fall. The real gainers are the well-off that already hold housing assets.
This brings me onto the missed opportunity in the Government’s new legislative agenda. The Prime Minister has talked about addressing the social care crisis in the UK but ducked the issue. In my opinion this is the most important current social issue; from demographic trends we know it will only get worse. However, unless governments have a change of heart about housing and recognise that people who have benefitted from the massive appreciation in the asset class need to shoulder more of their own costs, we are destined to fail to get a grip. It is not easy – Theresa May tried and failed to convince voters of this subject – but it seems inequitable that the State should protect inheritances of the already affluent. The irony is that our obsession is due to housing being seen as a financial asset rather than a place to live. If it was felt that house prices were going to be stable perhaps more money would be diverted into the productive parts of the economy.
Cash, government bonds and currencies
There was little news on the currency and cash front; sterling was a bit firmer.
Data was generally strong last week. April UK retail sales surprised on the upside – although consistent with Google mobility data. Interestingly May mobility data suggests this growth has not been maintained and may explain why gilt yields were broadly unchanged on the day.
The US PMI followed the euro area and UK in strengthening. The composite US index rose from 63.5 to 68.1, being led by services. Overall, PMIs are consistent with strong growth – particularly in the US – but as my colleague Melanie Baker reminds me, “PMIs are really a breadth rather than depth indicator”.
One feature of bond markets in recent weeks has been the rise in yields in Europe. A month ago French 10-year yields were negative – they are now at 0.25%. Italian yields have risen more, from 0.6% to 1%. Over the same period US and UK yields are up less than 0.1%. The latest Euro PMIs highlight the recovery going on: euro area new orders hit a nearly 15-year high and the output price measure was at its highest since 2002.
US treasury and UK gilt yields fell back a bit over the week but there was divergence in implied breakeven inflation. In the US, breakevens declined across the curve whilst in the UK they continued to rise – with all maturities reaching year-to-date highs.
Sterling credit spreads were a touch wider on the week – although still near year-to-date lows. We bought a shorter-dated subordinated bond issued by BNP but most of our focus was on trying to buy in the secondary market – which is quite difficult.
Our global credit team remained busy with results and new issues. High yield indices nudged towards 2021 highs, although there was a small pull back in spreads. Probably the most interesting global credit that we bought last week was a new issue from Deluxe, a cheque printing business. This may not sound appealing – but the business is cash generative and offered a very attractive 8% coupon.
We may be at the point of maximum concern about inflation. Despite stronger data, nominal bond markets were little changed – complacency or foresight? I still veer on the side that we are witnessing a transitory impact and that global economies are not strong enough for a meaningful rebound in prices. What I am surer about is house price inflation, which if sustained, does not end well.
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