Navigating uncertainty: what lies ahead for the U.K. economy?

Market update

Economic news

• U.K. consumer confidence improved by five points, after the six-point drop seen in July. Overall, consumer confidence is almost at a year-on-year high, just one point below the peak we saw in June.
• Final services and manufacturing PMI showed contraction in August, coming in at 49.50 and 43 respectively.
• This may indicate that the effects of the Bank of England’s (BoE) tightening cycle have finally taken effect, easing expectations for the next inflation and wage data releases.
  • Although GDP for the second quarter of 2023 showed expansion at 0.20%, PMI may be considered reactive and real-time economic indicators.

• This brings into question where the U.K. economy is headed. Is inflation on a downward trajectory, while the economy is benefiting from growth?
  • PMI data indicates that the economy should contract, and with wages continuing to grow and unemployment numbers low, will this lead to further inflationary pressures?
• BoE Chief Economist Huw Pill remarked last week that rates may not need to rise much further than their current levels to keep inflation under control, but may need to sit at elevated levels for longer than currently predicted by markets. Pill’s comments were echoed by Governer Andrew Bailey, stating that he believes “we are much nearer now to the top of the cycle." The recent data releases have brought down expectations of the terminal rate to c. 5.60%.

Sterling rates markets

• Shorter-dated gilts had a volatile end-of-August period, with yields of five years moving as much as 30 basis points intraday.
• Levels have stabilised in the last three days, at slightly lower yields than what we saw mid-August across most tenors.
• Low volumes through August may have contributed to increased volatility around key news events.

Housing association spreads

• Housing association (HA) secondary spreads have widened further from their early August lows, increasing by two basis points across all three tiers.

Bank market

• The RSH (Regulator of Social Housing) quarterly survey validates a prevailing sector trend:
  • New financing within the sector stands at £1.8 billion, notably lower compared to the three-year average of £2.9 billion.
  • 57.00% of the new facilities comprise of bank funding, predominantly revolving credit facilities. HAs continue to favor short to medium-term flexibility and avoid locking into the current level of long-term rates.
  • However, RSH figures do not provide details on hedging of new bank debt.
  • Interest cover performance has reached an all-time low, with a further predicted increase in interest payable over the upcoming 12 months.
  • Cash reserves have hit an eight-year low.
  • Capitalised repair expenditure is projected to reach a record high.
• These trends were anticipated and mirror market expectations, consistent with the prior quarter’s consensus.

Capital markets

• Places for People (PfP) increased their EMTN programme from £2.0 billion to £3.0 billion.
• Southern Gas Networks issued £500M in two tranches, both intermediate tenor:
  • £200M tap of their 2031s priced at +190 (IPT 195), with reasonable cover of £315M in the book. Given the low 1.25% coupon, the bonds priced at 67.87.
  • £300M of new 11.5Y bonds priced at +200 (IPT 205), books were reported at £490M.
  • Yields were 6.40% on the 2031s and 6.65% on the 2035s.
• Motability issued two tranches on 4 September:
  • A GBP250M 12-year tranche that did not benefit from any tightening from IPT.
  • Concurrently, a GBP400M 25-year tranche which had stronger coverage (1.75x bid to cover, 700M order book) and tightened from +110 to +100.
• The wider bond markets had a busy week with volumes picking up from a quiet August, particularly in Euros where we saw a number of financials and SSAs come to market.

Indicative pricing