Things are better than expected. Time to put up rates!

So we have accelerating wage growth and productivity was up in the second half of last year. Luckily productivity is currently ahead of wage growth which is a good thing, but Bank of England forecasts are predicting wage growth to rise to 3% this year and to get ahead of productivity growth which is not so good. The path seems set for rates to hit 0.75% and the City is betting on this happening by May. So as the year moves closer to Brexit we start to crank up the risk factors.

We still don’t know what the Treasury model of the UK is making of all of the conflicting inputs including a forecast of QE withdrawal. Once this happens it should have its own impact on reducing inflation. But as Dame Minouche Shafik, previously Deputy Governor of the Bank of England reminded us on Desert island disks at the weekend, Economics isn’t a precise science given that we have to consider the behaviour of people. Wise words and a timely reminder that no matter how much the economic boffins tell us that they know how things work… the really don’t with any degree of accuracy. So when the Bank decides to increase rates let’s just hope that it considers the human factor.

Elsewhere in Europe we have the Italian elections next Sunday March 4^th. The rise of the right and anti-immigration parties are moving the elections towards a flash point with an engaged and angry electorate. We also have the German SDP postal vote on their coalition with Merkel’s CDU … and that might prove to be more important. Markets seem to be of the view that the Merkel leadership is unassailable and that things will carry on much as before. But that seems at best wildly optimistic. Voters are becoming increasingly disillusioned with the increases in immigration: since 2015 Germany has received 1.38mn ‘initial asylum applications’ and in the short term there has been a significant increase in crime according to a controversial government-commissioned study published by the Zurich University of Applied Sciences. So, as we continue to focus on domestic issues and the latest state of play of Brexit negotiations, it would be easy to miss the significant issues in Europe right now which just could have some major impacts on us. Whether we are in the EU or not.

What an interesting week!

What an interesting week we’ve just had and what does it mean going forward?

As a professional Treasurer and market pundit I’m supposed to be an expert on all market moves and with a coherent theory of what’s happening, why and what happens next.

Well I’m going to let you into a secret – reading the markets right now is pretty tough.

There are so many conflicting risks and issues in the market and the Global experiment with loose monetary policy and economic stimulus means that no one really knows what the consequences of all this is going to be. Don’t let anyone fool you into thinking differently.

We’ve had close to zero interest rates for some time – so long that many in market don’t realise that this isn’t normal. It isn’t! And in the UK alone we have had £435bn of QE which many feared would stoke up asset values and create rampant inflation. And by and large that hasn’t happened either.

Global investors have been chasing yield and this has not been possible through Gilts or deposits and so has helped fuel the spiralling price of equities. In the US, regardless of the political scene (some would say because of – I’ll let you decide), the economy is now growing well and, with almost full employment inflation, now beckons. This means rates will have to rise more quickly. At the same time the Fed is looking to reverse out QE which is giving fears that this will be bad for the economy and that Bull run on equities should end. Who knows if that’s true? And all this at a time when a new and economically inexperienced Chairman of the Fed has barely got his feet under the desk

But what of the UK? Last week the vote was to leave rates on hold but for Mark Carney to signal that rates will have to rise sooner rather than later. This is the Governor’s forward guidance that he is so keen on.  At the same time we have a possible withdrawal of both QE and the remaining asset purchase schemes such as TFS and all with the backdrop of the Brexit ‘fog’. Piling on risk and uncertainty is not good for consumer confidence or businesses trying to plan.

At an international level we will have to see if the Bull run has well and truly ended or whether this is just a temporary volatile period. Was it just the price correction driven by market fundamentals of an overpriced equity market or something deeper? What about the influence of High Frequency traders using AI for algorithm based trades? No one knows! Many will argue that fundamentals are still good and that this is just a market wobble that will soon pass. I’m not so sure. One to watch because despite our tendency to look inwards in the UK, we can’t escape the wider panics in Global Financial markets…as we saw in 2007.

TFS - End of an era?

It’s still so early in the New Year but already we have seen the end of the Funding for Lending Scheme – a cheap source of funding to banks and building societies.

Soon, by the end of this month, we will probably see the end of new borrowings under the ‘Funding for Lending on speed’ otherwise known as the Term Funding Scheme (TFS). This was put in place in August 2016 at the same time that Base Rates fell to ¼% and it was the Bank of England’s mechanism to ensure that the rate cut was passed onto borrowers. In essence, lenders could borrow under this scheme at Base Rate flat. Right now there’s nearly £107mn drawn under this scheme and it was increased in size as recently as November last year.

The effect of the TFS has been to fuel mortgage lending at subsidised rates and dampen the requirement  for more conventional funding such as retail deposits, securitisation and covered bonds.

So, assuming that TFS is not extended – there’s always room for a last minute reprieve – then what will this mean? Well for a start we will begin to see more competitive retail deposits. Good for savers but expensive for lenders. If a price war starts for deposits then not only will they get more expensive as a funding source but they may well start to become more volatile as deposits move from one bank to another chasing the best rate. That’s not good. Expensive and unstable. Definitely not ‘strong and stable’.

Securitisation and covered bonds should make a come-back. Since the credit crisis these funding mechanisms have been decidedly muted and we really need the large historical issuers such as Santander, Lloyds, Barclays and Nationwide to re-start their programmes in earnest. Although this could have the short term effect of increasing securitisation costs for everyone as the supply and demand dynamics cut in, medium to long-term this can only be good news as we finally get these markets back on track and focus investors on buying them. On the whole – I can’t wait for these distorting schemes to go. They were very important at the time and have done their job. Now we need to get back to business as usual. Finally!

And mortgage rates? Well they will have to rise to reflect the increased funding costs. Standby for some last minute cheap deals as lenders take their fill of remaining TFS availability. Make hay while the sun shines!

It’s a generation thing

The total value of housing stock rented to 35- to 49-year-olds across the UK has increased in value from £66bn to £363bn in the past 14 years, according to Savills estate agency. Previously, we would have expected people in this age group to have bought their first home.

According to Lucian Cook, Savills’ head of residential research, more people aged 35–64, either through choice or necessity, are now renting. “We’re seeing the lack of accessibility to homeownership that was confined to the under-35s move up into the next age group,” Mr Cook said. “With a finite amount of social housing stock concentrated in older households, a lack of access to owner occupation is not just affecting the under-35s but beginning to feed up into the 35–49 age group’

A substantial shift then in a relatively short space of time.

Further along the spectrum, Legal & General report that the shortage of suitable housing for older people in Britain is keeping homeowners stuck in properties worth £820bn, leaving 7.7m spare bedrooms empty. This research suggests that almost a third of homeowners aged over-55 have considered downsizing in the past five years yet only 7% have actually made the move. Just 2% of the country’s housing stock is designed with pensioners in mind.

The L&G study claimed that if all 3.3m over-55s looking to downsize could find suitable homes, the shift would unlock 18% of the country’s property market, worth £820bn. That’s a lot of housing stock which could – should – be utilised.

This made me realise that the issue we’re facing is not simply a lack of housing stock, it’s a lack of the right type of housing. We need intelligent planning that takes the changing nature of households into account.

Part of this thinking should be making downsizing an attractive and viable option for the over-55s. While affordability issues may still be prevalent for 35–49s in terms of buying rather than renting, it might ease supply, reduce house prices and offer Generation Rent a few more options.

Don't get hung up about Help to Buy

Among many other revelations on March 16^th in the budget the Chancellor announced that the Help to Buy (HTB) scheme would be extended for new build homes. This is the so-called Help to Buy 1  shared equity scheme rather than the guarantee scheme. So is this a mistake, stoking up a housing bubble further, a dastardly plot to get his hands on more stamp duty, a shallow political scheme to get more votes or a genuine move to continue support for a key component of the economy? To answer this you have to consider the financial assistance that has been provided in the round. Help to Buy is a relatively small component of this and that probably gives you a hint about where I’ll be going with this.

When the funding crisis kicked off in 2007 the UK economy, global banking system, mortgage markets and housing markets were facing a massive problem. Armageddon is not an exaggeration. And the Bank of England and Government dealt with it. Eventually.  Not to have provided any support doesn’t bear thinking about and any quibbles about potential housing bubbles are irrelevant against that backdrop.

In my view the two biggest forms of support for the economy , mortgage and housing markets are not HTB but instead are QE – some £375bn of which has been pumped into the system and Funding for Lending. But taken as a whole all of the schemes including HTB have played their part. In some ways the role of these schemes is to underpin confidence and looking at the markets and economic regeneration underway today that seems to have been achieved.

So is HTB likely to cause a bubble? I don’t think so. All of the feedback I hear is that the majority of users of HTB are outside of the superheated London and South East areas and are for loans of less the £300k and so the £600k limit could easily be reduced without effect. Is the Chancellor doing all of these things just to ensure the health of the housing and mortgage markets or does he have ulterior motives? Well who can know with certainty but the election is near. I stress again though, other stimuli is having a much greater effect than HTB in my opinion. Will it all end in tears?  Well I hope not for all our sakes but there are various levers that the Bank of England/PRA have – so called macro prudential levers and of course interest rates. I’m sure these will be used as and when necessary and with care so as to not cause unnecessary shocks. I don’t think the industry should get hung up about HTB in my view.

No More FLS for mortgage lending

The Bank of England have today announced that they are refocusing the FLS from 2014 towards business loans and away from mortgage lending and I for one am pleased.

In fact I was surprised in April when the Bank of England announced an extension of the FLS through to January 2015 from the original January 2014 deadline.

Why should FLS for mortgages go? Well it has to be remembered that FLS was there to meet a crucial supply of credit and funding to the markets at a time when debt capital markets were still damaged from the Global Financial Crisis. It was necessary. But it was always the plan that this would provide funding until markets recovered. And there is plenty of evidence that markets are well on the way to recovery as recent debut RMBS issues from Precise and One Savings Banks have shown.

The market needs to get back to core funding: securitisation, covered bonds and retail deposits. It needs to be weaned off FLS and other forms of Government support and now is a good time. The UK economy is making good progress, debt markets are repairing and UK housing market activity is picking up. In some respects it’s all going too well and there have been signs of ‘credit creep’ and margin compression. Signs of a buoyant market. But as the Bank of England say today in their Financial Stability Report  “… risks may grow if stronger activity is accompanied by further substantial and rapid increases in house prices and a further build-up in household indebtedness, which is already elevated for some households. These risks would be accentuated if underwriting standards on mortgage lending were to weaken as has been the case in previous house price cycles”.

 So together with the FLS announcement we have other measures being taken by the Financial Stability board by way of capital changes and credit stress tests and this shows that the markets and economy are being very carefully monitored and managed. Frankly this should give us confidence that the market is being managed to sustainable end shouldn't it? It does me.

Funding for Lending Scheme 2 – the Final Story?

As soon as the Bank of England said that the Funding for Lending Scheme (FLS) was temporary and would not be extended we should have known that change was on the cards. This has happened before with the predecessor scheme the Special Liquidity Scheme. Remember it?

When the FLS was first introduced, Sir Mervyn King said it could only be a temporary solution and must be used as a "window of opportunity" to "restore the capital position of the UK banking system". I guess it depends on your definition of temporary and perhaps underlies the problem we have with the banks and the economy not being in the state they need to be right now.

Much has been written about the FLS. Quite a lot of it negative in that it was a blunt instrument, wasn’t being used as intended and should have been made available to other lenders who might be more prepared to focus their lending efforts on the sectors that the government really wanted served: namely lending to SMEs.

I have written about the FLS as well. I have defended it when others have knocked it. I have recognised that it has done some good for all lenders whether directly or indirectly. The amount of liquidity it has provided has allowed Libor rates to fall to more acceptable levels without supply shortages pushing up rates. Yes it has been unfair in not providing support to non-banks although I think we have to recognise that the Bank is trying to provide solutions within existing frameworks (the Sterling Monetary Framework in this case) that have the biggest impact on the markets and economy possible without providing an unwieldy solution.

I have also argued that the FLS should cease when the Bank said it would because it is going to dampen the revival of the core funding markets – covered bonds and securitisation - that we really do need to see re-emerging in rude health. How will we know when to believe them when they really mean to withdraw it? Yesterday’s news won’t help on that score.

The other issue that the Bank has had to work around are the State aid rules. You can guarantee that any changes of the scheme to focus assistance to one sector or another will be scrutinised by hordes of apparatchiks sitting in Europe to determine whether this constitutes an unfair distortion to the markets.

But however they have done it, this FLS Mark 2, the “Super Improved” version has done just that: under the new deal, every pound of additional lending to small and medium-sized enterprises (SMEs) next year will allow the lender to access £5 of discounted funding from the Bank and in an effort to accelerate the flow of credit into the system, each pound lent to SMEs for the rest of this year will allow a draw-down of 10 times that in 2014. This shows how seriously they are taking it.

And what of the other announcement, that non-banks can have a look-in but not directly? Well I share some of the scepticism I have read online that this won’t work because trying to find a bank to act as a ‘conduit’ through to the FLS is going to be hard in practice. But better than nothing. At least there is a mechanism for access and the more imaginative among us can work with that. We have to remember, the Bank isn’t trying to be fair, it’s trying to find a solution that works in the way they need it to and quickly. Inevitably that means a tweak of the existing scheme rather than a wholesale re-write. That automatically rules out direct access for non-banks.

So having seen the original FLS, how will the sequel pan out? One to watch. I suspect we may not have heard the end of this one.