UK inflation fell to a 10-month low in January, driven by lower food and gas prices, prompting expectations of a possible Bank of England rate cut in March.
However, gilt yields rose sharply yesterday, with five-year yields up around 19bps, 10-year up 14bps, and two-year up 12bps, reversing some of the easing in borrowing costs and putting upward pressure on mortgage rates.
Nicholas Mendes, mortgage technical manager at John Charcol, said: “The next MPC meeting is 19 March. In a fast-moving, unpredictable backdrop, the picture could look materially better by then, or it could deteriorate further. Either way, a near-term cut is now clearly less likely than it was even a week ago.
“Even if the conflict proves short-lived, the inflation story does not automatically reset. The medium-term issue is not just higher oil and gas prices, but the risk of disrupted supply and the knock-on effects that come with it.”
According to Mendes, the bigger geopolitical and economic risk is supply disruption, not simply the initial spike in prices. How long the conflict lasts, and how long supply chains are impaired, will be a major driver of the macro outlook.
There’s also a clear sense that both sides have taken lessons from Russia’s war in Ukraine, with energy infrastructure being targeted. That is the pathway to wider global fallout, because energy markets transmit shocks quickly.
Mendes also highlights that Qatar has reportedly halted some LNG production after facilities came under attack. Around 80% of its LNG typically goes to Asia, so Asian buyers are likely to be scrambling for alternative supply. LNG production can be shut down quickly, but restarting is not immediate and can take roughly a month, so the impact is unlikely to be limited to a few days of volatility.
The US exports primarily to Europe, but if Asian demand spikes and buyers are willing to pay up, cargoes can be redirected. In practical terms, that means higher prices can hit buyers almost immediately, even before “new” supply is arranged.
Mendes continued: “Europe remains particularly exposed on gas because storage capacity is limited and inventories are currently low. It is helpful, in relative terms, that Norway is a major supplier to both the UK and Europe, with flows into Europe linked via the UK, but the broader point is that Europe has less buffer than it would like in a supply shock.
“On Panmure Liberum’s numbers, if oil and gas prices stay around current levels for the rest of this year, the uplift to UK inflation could be roughly 0.3% to 0.4%. That’s not catastrophic in isolation, but it is enough to complicate the path for rate cuts and keep lenders cautious.
“A separate, uncomfortable dynamic is that Russia could be a beneficiary of higher energy prices, particularly if there is less political appetite to enforce sanctions aggressively in a shortage environment. It will be worth watching whether enforcement action against “shadow” tanker activity stays as firm if supply tightens.”
Santander’s cuts yesterday will have been signed off last week before this latest jump in yields fed through. With uncertainty higher and wholesale funding costs rising, it would not be surprising to see lenders turn more defensive.
Mendes added: “In practice, that can mean rates rising by more than the pure move in funding costs would justify, simply because lenders price in extra margin when visibility worsens.”
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