Mixed inflation signals complicate rate outlook for social housing financing

Market update

Economic news

• April's inflation figures showed a large easing in the headline number, with CPI coming in at 2.30%, down from 3.20% in March. Core CPI also fell to 3.90% from 4.20% the month prior, and the peak of 7.20% in May 2023. The market and Bank of England (BoE) forecasts had been expecting a slightly larger fall.
• Energy prices were the largest contributor to declines in the headline number, with household fuel costs down 12.00% over the 12-month period. However, other measures of inflation suggested continued pressure on the BoE’s two percent target.
• Services inflation fell slightly to 5.90% from 6.00% — a level that remains uncomfortably high for Monetary Policy Committee (MPC) members. In fact, their three-month-on-three-month annualized figures, which are intended to mute base effects, showed services inflation up from 4.40% to 5.60% in the latest set of data.
• This contradictory picture will pose a dilemma for the BoE’s rate cutting path. We are likely to see MPC members split into two camps, one of which will see April increases as a one-off, and another group which will see a reason to pause in June. Either way, May’s inflation print will now be more of a focus point.
• The downward path for rates may not be as smooth as markets expected, and we are likely to see further bumps along the road both in the U.K. and further afield. Housing market data in the U.S. and French inflation data will both be causes for concern among Fed and European Central Bank (ECB) policymakers.
• Prior to the inflation data, markets were pricing in the first 25-basis-point rate cut by the BoE for August, with two 25-basis-point rate cuts priced in by year-end. Markets are now pricing in the first rate cut for November, with no further cut in their meeting on 19 December.
• U.K. retail sales slowed in April, with year-on-year sales down 2.70% from growth of 0.40% the previous month. Sales from March to April also fell to -2.30% compared to the previous release at -0.20%.

Sterling rates markets over the past fortnight

• Rates are on the rise once again. The higher-than-expected inflation print saw gilt yields surge, up by over 30 basis points at longer tenors. This market selloff erased much of the gains we had seen in the rally since the start of May. Rates are now at levels comparable to the end of April.
• The SONIA swap curve saw similar movement, although the curve is significantly flatter than gilts. Rates remain lower for all tenors of seven years and above, where despite a small pickup rates between seven-year and 20-year swap rates the swap curve is negatively sloping.

Managing floating rate exposure

• Chatham is starting to see housing associations (HA) consider entering into new fixed-rate debt, or hedge existing floating-rate liabilities, despite levels remaining high in the context of the last three years.
• There is an increasing acceptance that rates may not fall far enough or soon enough for many borrowers, and against a backdrop of increasing floating-rate exposures, many are considering fixing at current levels. Even if in some cases, this may be shorter than we have seen previously.
• For bank debt, lead times on any new interest rate management exercise have lengthened, as many lenders will be looking to transact new fixed rates under a loan-linked or standalone ISDA. Please get in contact here to see how the team can assist.
• For capital markets, those with existing documentation or programmes, are in a better position. Four to eight weeks for others is not unusual if fresh issuance documentation is needed. We expect those with the ability to choose to issue sooner rather than later.

Capital markets

• Clarion Housing (Moody’s: A3, S&P: A-, Fitch A+) issued a £250M 33-year sustainability linked bond from their EMTN programmes.
  • Issued at a spread of UKT+95bps, this represented a good revision on IPT of UKT+110-115. Books were reported at 3.5x cover, not surprising given the high profile of the issuer as the U.K.’s largest HA.
• The bonds priced slightly below par at 98.676 to yield 5.462%, rounding the coupon at 5.375%.
• Prior to the issue, Clarion obtained an A+ from Fitch, sitting alongside the existing Moody’s A3 and S&P A-. This helped differentiate the credit from other large issuers in the A3/A- ratings space such as Places for People (PfP).
• At the time of this writing, bonds are bid slightly down at 96.91 for a spread of +96.3 bps. It will be interesting to see how these perform and whether the spread compression we have seen since the beginning of the year can hold through summer if we see greater primary supply from other HAs and the wider corporate and real estate space.

Indicative pricing