The inflationary tide is turning faster than expected and although consumers and companies may still struggle amid the wave of higher prices, they are wading out of the danger zone.

Coming in a 7.9 % headline CPI is still almost quadruple the Bank of England’s target, but the current of price increases is not as strong, and the signs are it’ll become weaker as we head through the year.

Receding food inflation is hugely welcome for households who face swimming in debt as their bills have mounted rapidly.

LIS Show – MPU

Core inflation, stripping out volatile food and energy, is also moving in the right direction, coming in 6.9% in the 12 months to June 2023, down from 7.1% in May.

Sterling has fallen back against the euro and the dollar as traders assess that the Bank of England won’t have to raise rates as far and as fast as feared.

A lower pound puts overseas earnings under more pressure which is partly why commodity focused stocks are among the fallers today, amid ongoing worries about the slowdown in China.

The expectation that borrowing costs won’t be pushed up quite as much as forecast have given a leg up to companies in sectors which are very sensitive to higher interest rates.

Housebuilders are among the gainers in early trade, following on from a strong performance yesterday after Kantar data showed food inflation slowing. Sentiment surrounding housebuilders has been hinging on the direction of inflation and interest rates, and concerns that affordability is being sideswiped as mortgages become much more expensive, so any signs that homeowners might show more resilience is being welcomed.

Banks are also gaining today, as while higher net income margins may not get quite so much of a boost if the terminal interest rate ends up lower, it’s offset by expectations banks won’t have to set aside so much for loans turning bad.

Consumer discretionary stocks are also among the gainers, with JD Sports on the front foot, in expectation that shoppers might still splash out on a new pair of trainers if mortgage outgoings or rents don’t rise quite so high as had been forecast.

But Bank of England policymakers are still likely to heed red flag warnings about wage growth in the private sector, which in the three months to May was on a steep trajectory of 7.7%, the largest growth since the pandemic.

There is still concern that companies will continue to be under pressure to pass on wage hikes through to higher prices, especially with consumer spending proving so far to be more resilient than forecast.

So, the Bank of England is still likely to raise interest rates in August by 0.25% but looking into the Autumn, the waters are very muddy and it’s now looking less likely that rates will reached the ‘ouch level’ of 6.5% but instead there is a chance they may not even reach 6%, providing some small solace for homeowners who need to remortgage or those waiting for a first step on the ladder.

With the jobless total inching up by more than expected, employees may already be more reticent about demanding further big hikes.

Plus, lockdown savings which were once piled up high, are being eroded, and consumers look set to turn more cautious ahead.

It’s estimated that only around 40% of the impact of higher interest rates has already fed through to the wider economy, so policymakers may need to go careful on the interest rate tiller to stop the economy capsizing into a deeper recession, and instead steer into a milder downturn.

More companies are feeling the toxic shock effect of higher borrowing costs and dwindling consumer demand.

Research by strategy consultancy EY-Parthenon shows that profit warnings have jumped to a level not seen since the Great Financial Crisis, with more than one in six listed firms issuing one.

Insolvencies have also shot up by 27% compared to last year, with the vast majority company voluntary liquidations which totalled 1,759 in June.

While some may have been zombie firms kept on life support by pandemic cash and ultra-low interest rates, the worry is that viable businesses are also being forced as multiple headwinds combine into a perfect storm.

Fears of frailty coming through in US corporate results have evaporated to reveal a show of strength.

Earnings have largely beat profits estimates with the banking sector in focus this week providing a solid set of numbers. But management teams are bracing for harder economic times, with higher provisions being set aside for loan losses in the second quarter compared to this time last year.

The US may appear to be avoiding a hard landing, but a big chunk of the monetary tightening we’ve seen will not yet have fed through and a mild recession still looms.

Susannah Streeter
Susannah Streeter, head of money and markets, Hargreaves Lansdown.
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Susannah Streeter
Susannah Streeter, Head of Money and Markets, Hargreaves Lansdown

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