Black clouds over base rates

Drones still blot the skies over the Middle East, and while US president Donald Trump has said his war is “very complete”, little resembling peace has broken out.

It may feel callous to think about local concerns, but as we assess in this week’s analysis, the knock-on effects in the UK will prove hard to ignore.

Higher oil prices inevitably feed inflation, which in turn has waved Bank of England (BoE) rate cuts over the horizon, more rapidly than HMS Dragon.

As Quilter Cheviot analyst Oli Creasey told us, hopes of two rate reductions this year are history: “Now you are looking at none.”

How the MPC might react to the new conflict, given the potential influence of hindsight, remains to be seen

Or worse. On Monday morning, oil prices topped $116 per barrel – not far off twice the $60 price at the start of the year – and in the afternoon, the Financial Times reported that the swaps market had briefly priced in the prospect of a BoE base rate rise before the end of the year.

Thankfully, those bets faded as oil prices softened.

As of Wednesday, the barrel price is back below $100, where it will hopefully stay, keeping the prospect of rate hikes at bay.

“Markets now see a very small chance of one cut this year and a small chance of rate rises next year, according to levels implied by swaps contracts,” the FT reported on Monday afternoon.

The price of UK government bonds has also dropped sharply since the conflict started. Two-year gilt yields rose to 3.95% on Wednesday, up 0.35 percentage points over the month (though still 0.27 points lower than a year ago). Yields on longer-dated gilts have also risen, though not as sharply.

If maintained, these price shifts will feed through directly to losses in the value of UK property as a comparative investment.

Market sentiment is one thing – what the BoE’s Monetary Policy Committee (MPC) will actually do is another. Uncertainty is underscored by the fact the nine-member MPC was split four to five over whether to hold or cut rates in both its February and December decisions.

The MPC will not be deaf to the heavy criticism it has faced for its clumsiness over the past five years. Critics argue it was far too slow to raise rates in response to rising inflation, in the wake of lockdown and the start of hostilities in Ukraine, worsening the economic impact of those shocks. And the same critics – not hard to find in property – argue it was again too slow to cut rates on the way down, dampening economic recovery.

How it might react to the new conflict, given the potential influence of hindsight, remains to be seen.

All of which does nothing for the nerves. Confidence, a timorous beast at the start of the year, is once again eyeing its burrow. Risk assessments look riskier and viability less viable than just a month ago.

The crowds attending Mipim should enjoy the sun. It might not come out again for a while.