What will 2022 bring in the markets?
Published January 2022
Having initially wrongfooted market expectations of a rate hike in November, the Bank of England managed it again by hiking Base Rate to 0.25% in December. Now all eyes look to February 3rd’s MPC where the strong expectation is a doubling of the base rate.
This sudden action is in response to the constantly growing inflation figures. Yet these figures mask lumpiness in price fluctuations, which are concentrated in certain markets, particularly energy. The rising cost of energy is expected to add 1.5% to inflation alone, causing misery for households facing an extra £1,000 a year. In the absence of a clear Government strategy, the Bank of England is being expected to use monetary policy to combat inflation, which is, as someone said in a market update recently, like expecting someone to fight a dragon with a wooden sword.
Nevertheless, markets have had a strong open to the year with significant issuance expected in January by those wishing to lock in rates before gilt yields rise. Secondaries are pulling slightly tighter as investors have new cash place after many investors had made all the investments they needed to in 2021 well ahead of calendar year end. Yet caution still abounds over persistent volatility in Gilt yields. That said, while the jump in the Gilt over the Christmas period–reflecting December’s surprise hike—isn’t great news for borrowers, there remains a healthy investor appetite for Sterling corporate bonds, with new issue premiums down slightly from the end of 2021. Yorkshire Housing’s £55m retained bond sale came in at 117bps over Gilt, a robust result showing the extent of investor interest. Further issuance in excess of £1bn is expected from housing associations in the first quarter of 2022.
Some forecasts predict the base rate to rise to 1.25% by the end of the year. If this were to happen, the cost of housing association debt will increase quickly and materially. With the Regulator having already cautioned about refinance risk given the extent of debt due to mature in the next few years, this presents a potential problem on the horizon.
On the other hand, house prices have continued to rise at a heady pace. Higher interest rates will likely favour savers, particularly those whose savings benefitted from the pandemic, albeit with spending power still being significantly eaten into by inflation being well above deposit rates. The housing affordability crisis will get worse workers do not see incomes rise. Whether higher mortgage rates will lead to a drop in house prices remains to be seen.
Fears over a lockdown forced by omicron seem to have subsided, and this is reflected in the Sterling market’s strong open, although concerns over the capacity for the NHS to cope with a rise in hospitalisations remain.
There are other potential pressures on inflation, some particular to the UK (the change in status of imports from the EU, plus continued issues over supply-chain hiccups). And one shouldn’t ignore the potential for both domestic political uncertainty (perhaps concentrated around the period of Local and Northern Irish elections in May) and geo-political upheavals in the Ukraine and/or US-Chinese relations.
Many in our markets have grown up accustomed to downward or static interest rates and stable inflation.
Overall 2022 looks set to be the paradigm shift in markets that many have been predicting would come as a result of the pandemic. All the indicators suggest that, barring any major events (which hardly seems likely to happen), by the end of the year the interest rate environment will be markedly different. While associations may have to start getting comfortable with a higher cost of debt than seen in the last few years, then, the sector shows familiar signs of strength and resilience that will continue to make it an attractive destination for investors’ cash.