A Windsor win?

A good week for

• Equities prospered, with Europe the best performing equity region, gaining c. +2% in sterling terms
• Oil gained +3.2% in US dollar terms

A bad week for

• UK and European government bonds weakened c. 1% in local terms
• The US dollar weakened 0.7% on a trade weighted basis

UK politics

Last week the UK and EU reached a new agreement to oversee trade between Great Britain, Northern Ireland and the EU. The new ‘Windsor Framework’ is designed to replace the Norther Ireland Protocol, which sought to resolve the challenge of avoiding a hard border with the island of Ireland. Under the original protocol, goods travelling from Great Britain to Northern Ireland, which were not at risk of onward travel into the EU, were exempt from customs and standards checks. Under the new agreement, the criteria for exemption will be widened, reducing the need for burdensome checks. In addition, the Treasury will have greater flexibility in setting VAT rates. While a successful negotiation signals a thawing of relations, and may facilitate the resumption of power sharing government in Northern Ireland, the agreement must still be passed into law. In addition, given that Northern Ireland is a small share of the UK economy, the economic impact is expected to be limited. Furthermore, not all of the checks meant to be conducted on goods travelling between the UK and the EU are being carried out yet, due to implementation difficulties.

Eurozone inflation

Eurozone inflation was stronger than expected in February, with core inflation rising. While the headline reading slowed to 8.5% year-on-year, versus 8.6% in January, core inflation accelerated to 5.6% from 5.3%. Energy prices continue to be the main driver pulling down headline inflation, with energy prices now 14% higher than a year ago, compared to 52% higher in October. In contrast, food prices have been contributing to inflation, rising 15% on last year, though in time base effects should begin to reduce the year-on-year impact. Excluding volatile energy and food prices, the strength in core inflation is a greater concern for the European Central Bank, with economists forecasting further interest rate rises. The case for additional monetary tightening is also supported by weaker gas prices, which have caused Eurozone GDP forecasts to be revised higher.

China economy

Early data suggests China’s economy is reviving, following the relaxation of strict social restrictions. Business survey data indicated a strong rebound, especially in the services sector. So far there is no evidence that the Lunar New Year travel period, which likely accelerated the spread of the coronavirus in 2020, has led to an additional wave of cases, likely because the virus was spreading at the end of 2022, giving some immunity. Data suggests that, after the New Year break, mobility within cities has improved to pre-pandemic levels, and inter-city travel has recovered to over 85% of pre-pandemic levels. Unlike in the UK and US, Chinese household balance sheets are likely somewhat worse off after the pandemic, and youth unemployment is still elevated, which could offer less support to consumption spending. However, early data suggest a strong rebound in priority categories, such as international travel.

UK economy

January’s money and credit data showed UK households saving less. Given the hit to real income growth from higher inflation, households will have to use savings to bolster consumption in 2023. In January, households added c. £3.5bn to liquid savings, below the average level of the pre-pandemic years. In prior months, households had added more to savings, suggesting consumers are cautious on the outlook for their own finances. The housing market is another factor influencing consumer confidence. Mortgage approvals fell to 40,000 in January, lower than December and almost half of the pre-pandemic average. February’s Nationwide price index also showed house prices -1.1% lower than a year prior, the fastest decline since 2012.

UK monetary policy

A key factor contributing to a weaker UK housing market has been the rise in interest rates. While this reflects the rise in the Bank of England’s base rate, the turmoil experienced during Liz Truss’ premiership pushed borrowing rates higher still. Mortgage rates have retreated from levels seen in the autumn of 2022, but UK interest rate expectations have risen in recent weeks. Although Bank of England Governor Andrew Bailey emphasised last week that further tightening was not a foregone conclusion - with the greater than expected strength in wage growth offset by weaker than expected inflation - the labour market continues to be stronger than the Bank forecasted. Furthermore, next week’s budget could provide more support for consumer spending which may ultimately bolster inflation.

Important information
The information contained in this article is believed to be correct but cannot be guaranteed. Past performance is not a reliable indicator of future results. The value of investments and the income from them may fall as well as rise and is not guaranteed. An investor may not get back the original amount invested. Opinions constitute our judgment as at the date shown and are subject to change without notice. This article is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Where links to third party websites are provided, Close Brothers Asset Management accepts no responsibility for the content of such websites nor the services, products or items offered through such websites.