January 2024 monthly update

Read our January monthly update – a roundup of the latest financial news and economic headlines.

UK inflation rate rises unexpectedly

For the first time in 10 months, the UK’s annual rate of Consumer Price Inflation (CPI) has increased. It has risen to 4% in December 2023 from the 3.9% seen in November. Due to this, markets are less optimistic that the Bank of England (BoE) will issue an early rate cut as the figure is double the inflation target set by the central bank. The cause of this rapid rise is reported to be tobacco duty and higher prices on seasonal airfare.[1]

Economists polled by Reuters last year had predicted that the rate would decrease to 3.8%. Since this has not transpired, traders in the swaps market (which deals with predictions of future BoE interest rates) have scaled back their expectations for 2024. Tomasz Wieladek, chief European economist for the investment firm T Rowe Price, commented: “the data today will make the BoE’s Monetary Policy Committee [MPC] more cautious. We could see rate cuts at a pace of once per quarter rather than once per month.”[2]

In response, shares listed on the FTSE 100 dropped 1.5% which is its worst daily fall since August 2023. Officials at the European Central Bank also released warnings that interest rates will remain high for much of the year to decrease inflation across the 20 member countries of the Eurozone. This was another trigger for the mass sell-off in stocks.[3]

Yields for two-year gilts that are sensitive to interest rates rose 0.16 points to 4.3% which is the biggest daily rise since August 2023 as well. Furthermore, benchmark 10-year gilt yields increased 0.14 points to 3.94%; their highest since mid-December 2023. Ahead of the Office for National Statistics (ONS) releasing the figures, the market-implied probability of the BoE first issuing an interest rate cut in May was 80%. This has fallen to 55% with traders betting on a smaller reduction in borrowing costs by the end of 2024. The pricing of the cuts is now 1.04%, down from 1.24% in early January this year.[4]

Chancellor Jeremy Hunt announced higher tax duty on tobacco and alcohol in the 2023 Autumn Statement. It is reported that this is the main driving force behind the increase in the annual rate. Tobacco prices rose by 16% while alcohol rose by 9.6%. Grant Fitzner, chief economist for the ONS, said that such prices were “offset partially by falling food inflation, where prices still rose but at a much lower rate than this time last year. Meanwhile, the prices of goods leaving factories are little changed over the last few months, while the costs of raw materials remain lower than a year ago.”[5]

Core inflation figures, however, surprisingly stayed unchanged at 5.1% even though analysts had expected it to fall to 4.9%. These figures exclude volatile areas such as energy, food, alcohol, and tobacco. This development will be monitored by the BoE before it announces its next rate decision on 1 February 2024. Moreover, services inflation rose from 6.1% to 6.2% while motor vehicle fuel prices fell by 10.8% in the year to December. This is compared to the decline of 10.6% in fuel prices in the year to November, after a decrease of an estimated 8p per litre for petrol and diesel on the month.[6]

The uptick in consumer prices combined with the rise in the cost of services would “probably be enough to quash any temptations at the MPC to start to change tone at its meeting in February”, said Thomas Pugh, economist at auditing firm RSM UK.[7] Reuters reported that living standards have fallen over the past two years due to inflation issues and this will contribute to the challenges that Prime Minister Rishi Sunak will face in the upcoming general election. Although, as a relief to households, food inflation eased to 8% in December compared to 9.2% in the previous month and is at its lowest rate since April 2022.[8]

Chancellor Jeremy Hunt argued that “inflation does not fall in a straight line, but our plan is working and we should stick to it” while referencing the USA, France, and Germany’s similar patterns. In the Eurozone, headline price growth increased to 2.9% in December (up from 2.4% in November) while it increased from 3.1% to 3.4% in the USA.[9]

Even though there are new risks to an optimistic outlook (such as disruption of shipping in the Red Sea and the fallout of possible tax cuts in the Spring Budget), economic analysts forecast inflation to resume its downward trajectory from February. Spring is also expected to bring large drops in the figures; helped by base effects and lower gas prices.[10] The calculations for January will take into account the 5% rise in the Ofgem energy price cap which has the potential to drive up the headline rate. City of London economists expect the cap to fall by 10% in April amongst a more general decline in wholesale prices which will, in turn, aid in bringing down overall inflation.[11]

Ruth Gregory, deputy chief UK economist at Capital Economics, commented that while the rise in inflation was “disappointing”, her research firm expects “favourable base effects and a fall in utility prices to drag CPI inflation below the 2 per cent target by April, leaving the Bank of England in a position to cut interest rates by June.”[12]

IMF warns Chancellor against tax cuts

The International Monetary Fund (IMF) has issued a warning advising Chancellor of the Exchequer Jeremy Hunt from introducing further tax cuts in the upcoming Spring Budget. According to the IMF, Hunt’s speculated cuts are “unrealistic” as the preservation of public services and investment implies higher spending than the statistics detailed in the government’s current plans.[13] The institution argued that the UK needs to reduce public borrowing while prioritising healthcare, education, and the fight against climate change.

IMF chief economist, Pierre-Olivier Gourinchas, stated that the country should aim to be on “the path towards fiscal consolidation”. As such, the Chancellor should be “trying to rebuild fiscal buffers […] in the context in which there are important spending needs” instead of implementing £20bn of personal and business tax cuts in November 2024.[14]

To provide evidence for these statements, the IMF has predicted that the British economy will only grow by 0.6% this year. That is the second-slowest growth rate amongst G7 countries (after Germany) and just marginally better than 2023’s rate of 0.5%. Meanwhile, the IMF’s latest World Economic Outlook estimated that Britain’s GDP will expand by 1.6% in 2025.[15] The UK’s public debt (as a share of GDP) has been forecast by the Office for Budget Responsibility (OBR) to rise from 89% this year to more than 93% within three years, in contrast.[16]

While Hunt is expected to cut Income Tax in the Spring Budget, the IMF has strongly urged him to increase Carbon and Property Taxes. Furthermore, they proposed that he eliminate loopholes in the taxation of wealth and income as well as reforming the pensions triple lock system.[17]

Gourinchas emphasised the importance of creating “medium-term fiscal plans that will accommodate a very significant increase in spending pressures.” He also provided some suggestions for the country: “you might think of spending on healthcare and modernising the NHS; spending on social care; on education; you might think about critical public investment to address the climate transition; but also to boost growth.”[18]

The Chancellor responded by rejecting these notions: “it is too early to know whether further reductions in tax will be affordable in the budget, but we continue to believe that smart tax reductions can make a big difference in boosting growth.”[19]

The Conservative Party want to push tax cuts into the Spring Budget since it would draw a dividing line against the Labour Party. They argue that Sir Kier Starmer, leader of the opposition, would raise taxes if he wins the general election. According to Labour, this strong warning from the IMF is “yet more evidence of 14 years of Conservative economic failure”. Shadow Chief Secretary to the Treasury, Darren Jones, stated that the ruling party have “left Britain with high debt, flatlining growth, high taxes and working people worse off.”[20]

Similarly, Richard Hughes, head of the OBR, said that calling the government’s post-election spending plans a “work of fiction” would be “generous” because the “government hasn’t even bothered to write down” such strategies for its departments.[21] The £13bn fiscal headroom predicted by the OBR in the 2023 Autumn Statement is heavily exposed to fluctuating assumptions on interest rates and data revisions. Recent estimates from the Treasury itself suggest that the headroom available for the Spring Budget may not be dissimilar to the November 2023 prediction. This will leave Hunt with only modest scope to realise his tax cuts and to achieve his fiscal goals.[22]

House prices rise surprisingly

As easing mortgage rates have aided in stabilising the property market, mortgage provider Nationwide has reported that British house prices rose more than expected in January. The 0.7% increase between December 2023 and January 2024 was the fastest pace seen since October and was far more than the 0.1% increase forecast by economists who were polled by Reuters. This is a turnaround from the 1.8% decline reported in December’s figures and has caused the average price of a home to grow to £257,656.[23]  Although, that is still down 0.2% compared to a year earlier.

Robert Gardner, chief economist at Nationwide, commented: “while a rapid rebound in activity or house prices in 2024 appears unlikely, the outlook is looking a little more positive”. In his view, this has been driven by “encouraging signs” for buyers since mortgage rates are continuing on a downward trajectory. Moreover, he said that “this follows a shift in view among investors around the future path of [interest rates], with investors becoming more optimistic that the Bank of England will lower rates in the years ahead.”[24]

The resilience of the UK housing market has prompted a more positive outlook for the wider economy, and it will be closely monitored by Bank of England (BoE) policymakers ahead of their meeting in February. In this meeting, the BoE is expected to still hold the benchmark rate at its 15-year high of 5.25%.[25] Recent data from the central bank showed that the average rate for new mortgages fell in December as well. This is the first time it has done so since November 2021 and coincides with mortgage approvals rising to a six-month peak. The rates on popular deals (two-year fixed mortgage rates with 60% loan-to-value ratios, for example) have also eased since summer, exhibiting investor expectations of lower borrowing costs.[26]

“While we expect that interest rates will remain at 5.25% this week, this will only help to steady the market further, providing buyers with the confidence that they can proceed with their purchase without the goalposts of mortgage affordability moving during the process.” Said Verona Frankish, chief executive of the online estate agent Yopa.[27]

While this view is optimistic, Nationwide warned that raising a deposit is still a major challenge for would-be homebuyers. The provider calculated that a 20% deposit on a typical first-time buyer’s chosen property now correlates to an estimated 105% of average annual gross income. Even though this is lower than the all-time peak of 116% recorded in 2022, it remains close to the pre-financial crisis figure of 108%.[28]

The Royal Institute of Chartered Surveyors (RICS) also released data showing that new buyer inquiries fell by 3% in December – a strong improvement from the 13% decrease recorded in November. This suggests that the decline in inquiries from new prospects has halted and Nationwide believes that there are “tentative signs” of more homes coming onto the market. However, the provider advised that interest rate changes over the coming months will be fundamental in helping households manage their property since affordability pressures dampened the market and led to lower activity last year.[29]

At the moment, a mortgage holder earning the average UK income and buying a house with a 20% deposit has a monthly mortgage payment equivalent to 38% of their take-home pay which is far above the long-term average of 30%. Mortgage rates would need to trend down to 3% to meet the 30% statistic used by affordability calculators. In London, especially, the average income of first-time buyers is around 55% more than the average income in the city as a whole. What this suggests is that an increasing number of new homeowners have had to turn to family, friends, or their inheritance to get onto the property ladder. From 2022-23, almost 50% of first-time buyers received help in raising a deposit – a figure that is close to double the 27% reported in the mid-1990s.[30]

Robert Gardner commented on the issue: “there remains considerable variation in affordability across the country, with pressures particularly acute in London, the south of England and East Anglia. Scotland and the north continue to be the most affordable regions, with mortgage payments as a share of take-home pay much closer to their long-run average.”[31]

The Financial Times, however, reported that the outlook for the property market is now more optimistic as mortgage rates continue to ease and household incomes are predicted to improve once inflation decreases further. According to Andrew Goodwin, chief UK economist at Oxford Economics, the era of nominal house price falls “is now behind us” and he added that “the prognosis for the housing market now looks markedly better than it did in 2023.”[32]