Embracing 6% as a new normal?

Market update

Economic news

• July U.K. CPI came in at 6.80% year-over-year, slightly above consensus of 6.70%.
  • This was a 1.10% fall from the June numbers — the second largest monthly fall in the last decade (only the 1.40% fall in February-March 2023 was larger).
• Energy prices were the largest driver of declines, where prices were down 15.10% over the month.
  • Recent news by Ofgem suggests a large amount of the declines in wholesale prices are being passed through to domestic consumers, with annual energy bills expected to fall to £2,074 in July from £2,500.
• Core CPI was stickier, remaining unchanged at 6.90% year-over-year. This poses a challenge for the Bank of England (BoE), who are likely to find headline inflation on a slower glide path to target than previously forecasted.
• Services inflation — the sector accounting for the majority of the U.K. economy — showed a 7.40% rise, up from 7.20%. Some of this can be explained by volatile components, such as airfares which rose almost 30.00% over the last 12 months. However, the broader picture is one of greater persistence in price growth across the wider economy, particularly around wages and labour where prices tend to ratchet in only one direction, upwards — embedding higher costs for firms.
• Markets are now pricing in a terminal rate of 6.00% well into 2024, showing some expectation that rate cuts are on the horizon by the third quarter of 2024. The most notable trend in forward rates has not been the terminal level but expectations on persistently higher rates through the medium term.

Sterling rates markets

• Inflation and wage releases caused markets to rally, pushing gilt yields up by 10 basis points across the curve from five-years onwards.
• The SONIA curve also shifted upwards, with rates rising by 10 basis points across the curve from tenors of two-years and above.
• This added to recent increases, with medium-and-long rates (10 years+) now trading c. 30 bps higher than the end of July.

Housing association spreads

• Housing association spreads (HAs) have remained unchanged over the past fortnight.
• Spreads are drifting at a year low, which may be reflective of the lack of issuance of sterling debt.
• Investor demand continues to be high, even with the sector’s credit picture deteriorating over the past year.

Bank market

• Fixed-rate bank debt has become more expensive as SONIA swaps continue to drift higher.
• HA borrowers have been happy to take on increasing levels of floating-rate debt, with the expectation of lower fixed rates in the future.
  • However, this can leave borrowers increasingly exposed to floating-rate debt in a rising rates environment — where there is already broad pressure on interest coverage ratios across the sector.
• Recent increases in market rates expectations have underlined this cost of delay, with medium-dated fixed-rate debt now at levels of 6.00% or above.

Capital markets

• Southern Housing sold their remaining retained bonds as part of their strategy to shift their core capital structure towards the bond markets.
  • This consisted of £68.5M of their 2035 2.86% issue and £20.0M of their 2036 2.38% issue.
• It was announced that they will increase the issue size of their 2043 5.25% issue by £100M, bringing total size to £400M.
  • £50M of these have already been sold on a deferred basis, leaving £50M still for sale.
  • Bond documentation for the increase in benchmark size is yet to be completed.

Indicative pricing