Inflation eases and rate cuts loom

Market update

Economic news

• The U.K. economic outlook is improving as inflationary pressures ease and markets anticipate the BoE's loosening monetary policy late this year.
• While CPI has fallen significantly to 3.20% in March from an 11.10% peak in October 2022, core CPI remains elevated at 4.20%. Historically, core CPI is lower than headline CPI because it excludes volatile elements such as energy, food, alcohol, and tobacco; however, the March core print (1.00% higher than headline CPI) indicates the persistence of non-volatile contributors.
• U.K. GDP is estimated to have increased by 0.60% in the first quarter of 2024, following the recession in the second half of 2023.

• U.K. PMI figures were also released, showing an overall positive picture. Construction PMI at 53.0 pointed to continued expansion despite some weakness in residential work, and the services sector outlook was positive with PMI at 55.0, thanks to a combination of lower inflation and improved consumer confidence. Services data did show that 39.00% of respondents had seen an increase in their average costs, indicating that underlying inflationary pressures in the services sector remain.
• The Monetary Policy Committee (MPC) left the bank rate unchanged at 5.25% in its May meeting, marking the sixth consecutive meeting with no movement. The Committee voted by a majority 7–2 to maintain the bank rate, with two members voting to reduce it by 0.25% to 5.00%, up from a sole vote to cut in March. While there is little doubt over the direction of travel, timing remains uncertain.
• The path forward for rates will depend on a number of competing ideologies from the MPC — hawks versus doves, internal versus external members, and activists versus gradualists. More importantly, the first cut from the Fed.
• Where does this leave HAs?
  
  • The key risk is if the Bank waits too long to cut interest rates, whether driven by uncertainty in the data (e.g., recent Labour Force Survey issues) or an unwillingness to be the first-mover among the main central banks. This could leave HAs facing a position of lower rental increases and higher rates, squeezing profitability and free cash flow through FY26.

Capital markets

• ARA Venn announced that it has provided Broadland Housing Association with £25M of funding through the Affordable Homes Guarantee Scheme (AHGS) under the existing 2053 Saltaire bonds.
• The spread over gilt was quoted as mid-30s, with an all-in rate of 4.95%. Given current market environment, the sub 5.00% rate is attractive given the tenor (c. 30 years), with the scheme continuing to benefit from the tightest spreads available in the capital markets for registered providers.

Covenant trends

• HAs are beginning to place more emphasis on the commercial terms of bank facilities, both in terms of financial and non-financial covenants.
• More supportive financing conditions in the capital markets, which carry comparatively lighter restrictions, may present borrowers with a more realistic "plan B."
• We expect this to place more pressure on bank covenant negotiations going forward.

Levelling Up, Housing and Communities Committee Report

• The House of Commons Committee report listed several key issues that the sector is facing and recommendations on how to address them. The government has two months to respond.
• The report outlined significant financial strain due to expenses related to investment into existing homes, decarbonisation and fire safety, and rent cap that limits income.
• These constraints have led to registered providers (RP) to reduce the development of new social homes in order to maintain financial stability. This exacerbates the shortage of social housing across the U.K., having an adverse effect on individuals in need.
• The report highlighted grant funding allocations and consideration of private investments into the sector, two factors which will have direct impacts on new unit delivery and the ability of future governments to meet any manifesto pledges later this year.

Sterling rates markets over the past fortnight

• Market rates continue to be sensitive to data releases and wider sentiment, with 20-basis-point movements over a fortnight becoming a regular occurrence.
• Since our last update, rates have rallied with gilt and SONIA curves down c. 20–25 bps on the medium- and long-end.
• Gilt yields have fallen by c. 9 bps since the MPC meeting on 9 May. While the MPC has reported that "monetary policy needs to be restrictive for sufficiently long to return inflation to the 2.00% sustainably in the medium term," markets continue to expect the first 25-basis-point cut to commence in August, with another 25-basis-point cut priced in for the end of the year.
• Notably, markets are expecting the Bank of England to commence its first rate cut prior to the Federal Reserve, with the first 25-basis-point rate cut priced in for November from the Federal Reserve. History suggests that this is unlikely, given the last time the BoE moved first was 2003, and before that, in the 1980s.

Indicative pricing