610: Brexit, Stagflation and the Oil Price – Impact for Property Investors
Brexit, Stagflation and the Oil Price – Impact for Property Investors
Brexit Shock: After the shock Brexit Referendum result of June 2015, Sterling crashed around 20% meaning import costs rose sharply. This kick started an inflationary period that has yet to play itself out. The Bank of England dropping rates from 0.5% to 0.25% to keep economic momentum only fuelled this inflationary impact. Inflation is now running at around 3% and rates have gone up 0.25% back to 0.5% - still a massive 2.5% below the inflation rate.
Net Migration: The uncertainty in how EU citizens will be treated during the Brexit period has slowed inward migration from the European mainland. This has put upward pressure on service sector job wages – like restaurant staff, cleaners – plus builders. The labour shortages are just starting to feed through into wage growth – and this of course will also fuel inflation in the next few years. For the ten-year period up to June 2015, the relatively high Sterling value, low wage growth and low inflation allowed record low interest rates to stay that fuelled the house price boom particularly in London and southern England. We expect net migration levels to drop from the highs of 360,000 people a year to something like 250,000 people a year by 2018 – also caused by a slowing economy with less jobs paid in a lower value currency compared to the Euro. The lower population growth and lower inward migration will also feed into lower overall GDP growth – knocking something like 0.5% off annual GDP growth per year moving forwards, since less services and jobs will be required and tax receipt will not rise as fast.
Oil Price: Oil prices crashed from ~$110/bbl early 2014 to $28/bbl by 2016 which gave a big boost to the global economy by reducing inflation, reducing input costs and allowing interest rates to stay low despite GDP growth picking up. The European Central Banks meanwhile continued to print currency to help drive inflation higher and boost asset prices for investors – giving away free money to the super rich global elite. But since late 2016, oil prices have risen firstly to $50/bbl early 2017 and recently up to $63/bbl by early November. Media talk of another oil price boom and shortages have started again, though we actually think oil prices will drop back again to around $50/bbl through to Aug 2018 as some large oil project in Kazakhstan, Canada and Brazil come on stream early 2018 (the last projects sanctioned before the oil price crashed mid 2014) – then we think oil prices will take off as supply shortages kick in end 2018 since there have been almost no new oil projects sanctions by non-OPEC countries in the last 3-4 years. We do not think US oil shale drillers will be able to close the gap by end 2018 since they make little money at current prices and will be trying to pay back their bad debts for years – therefore needing capital discipline.
The reason why we describe oil prices and our outlook is that – we predict that current oil prices rises will start to feed into the UK inflation in the next few months – adding around 1% to current levels – taking inflation to around worrying 4%. Then on top of this, by end 2018 – if our oil price prediction is correct, the Brexit uncertainties, unstable Tory minority government (read threat of a Labour government) and balance of payments deterioration caused by high oil import bills will put further pressure on Sterling – it will decline further. Then we will get more inflation feeding through from lower inward migration and a further rise in oil prices by end 2018. Unfortunately the Bank of England will start to look like it has lost control since it will be chasing the tail of inflation by end 2018 – needing to jerk up interest rates significantly – this will then raise mortgage rates and house prices could drop. The rental market will remain very strong as younger people choose to rent rather than buy in a risky and potentially dropping market. A recession would start in such conditions by end 2018.
Recessionary Risk: If interest rates go up too quickly, to defend Sterling and keep a lid on inflation, then of course there would be a recession and many people would lose their jobs – this would also feed into house prices – with drops across all areas.
Oil Prices: The key for investors is the oil price – anything over $60/bbl should be a major warning sign – anything over $70/bbl would definitely negatively affect the property prices in our view – because general inflation would rise, interest rates would rise, mortgage rates would rise then house prices would drop.
Bank of England Reactive Response: If you see oil prices at $50/bbl – then warnings over – you can relax a little – just worry about a Tory minority government and Brexit. We think Carney, the Bank of England chief, has way under estimated how bad inflation will be in 2018 - and he’s going to look like he’s panicking by mid 2018, particularly if oil prices are over $65/bbl.
Just to also flag some awful risks – many of them new – which are global in nature.
1. Trump-USA and China: The South China Sea remains a hot-spot with China claims to all the islands in this sea-region – don’t be surprized to see military action here – this could be with the US or Japan.
2. North Korea and the Kim Jong Effect: Kim Jong is a very dangerous megalomaniac – and he is up against Trump – both nuclear powers – so this could end very badly – especially for South Korea. Another missile launch or military mistake could lead to a horrific war.
3. Russia – Putin: An ever present uncertainty and danger. Ukraine is his bugbear – the EU/US involvement early on and Russia getting involved in a lot of Middle East military and political actions to keep pressure on the US. With the World Cup in 2018 – just around the corner Putin may keep a lower profile, but Russia is very unpredictable – just like Trump.
4. Saudi-Iran: These two countries are regional superpowers, regional competitors and completely dis-trust each other. The Saudi’s are Sunni and Iranians are Shia. The Saudi’s are Arab and the Iranians are definitely not Arab. Saudi is a family run autocratic monarchy. Iran is a Republic Democracy of sorts ruled with an iron fist with an overarching ruling religious presidential elite. Saudi Arabia is a mainly flat desert, Iran is almost completely mountainous. They have always deeply distrusted each other and are fighting a proxy war through other organisations and militias. Crown Prince Mohammed Bin Salmon or MBS are they call him is a 32 year old Saudi who is purging his Saudi enemies under the umbrella of an anti-corruption drive and is attempting to modernize Saudi in the process. If an all out war starts between Saudi and Iran that shuts down the Straits of Homez – then oil prices would skyrocket – then inflation with it – then house prices would drop sharply in the UK. One needs to keep a watch on this oil-energy region – since it is a genuine business risk for UK property owners and of course there is the worrying humanitarian side of any conflict.
5. Venezuela: The country is a basket case – with inflation running at 660% per annum and a government debt default highly likely in the next six months. 18 years of socialist mismanagement and corruption is finally taking a severe toll and regrettably it’s the general population that suffers with higher crime levels, food shortages, mass unemployment and power cuts. The country still produces around 1.9 million bbls oil/day but this is likely to collapse soon with the financial troubles and US sanctions imposed.
Brexit Side Show: When you look at all these things happening in the world, Brexit looks more like a tiny side-show – just image living in Seoul – we’d rather be in London or Glasgow! What we find difficult to believe is how an advisory Referendum was translated straight away into ”Brexit means Brexit” – and that Cameron bailed out on the day. Whether this was to kill off UKIP, or because Corbyn wanted out as well – we will never know. Or maybe the Brits are just very proud and/or honest and don’t want to U-turn. There is no doubt though that the whole business is extremely messy, distracting, unsettling and its only just beginning. For property investors it’s definitely bad news – because this whole process will get much worse before it gets better and it will take another 3 years at least. But after its all finished, as long as Labour are not in power by then – then we can breath a sigh of relief, not have to worry so much about Sterling dropping and inflation taking off.
Reason for the Vote Outcome: It’s worth though reminding ourselves that through all the emotion – some of the underlying reasons people voted to leave were: 1) concerns on uncontrolled mass inward migration, 2) UK democratic sovereignty over laws; 3) not being bossed around the Brussels, 4) the UK is a proud rather independent “island nation” that went to war to save Europe twice in 1915 and 1939 and can’t get used to being told what to do by the Germans and French.
Ever Closer Integration: Another key point is that staying in the EU means “ever closer” integration – including a combined EU Military – and we had got so far – they gave nothing in return (remember Cameron asking for help – came away empty handed) – and then 52% of the population said “enough is enough – I want a divorce”. We can’t blame anyone for voting Leave just as we can’t blame anyone for voting “Stay”. What we “can” do though is voice concerns about how the Referendum was translated into actions. Anyway, by all accounts if the referendum was held again, the result would be the same – so we better just get through it regrettably. It’s like saying you want a divorce, having some initial very negative early discussions with your partner, then engaging a divorce lawyer, start proceeding – then it’s not likely you would do a U-turn. And even if you thought again, the answer would be the same.
Debts Destruction: The silver lining is that everyone who has borrowed a lot of money to finance property – if they manage to get through the next 5 years – will see their debt levels in real terms decline because of the increased inflationary pressures developing. If you borrow £1 million in 2017 and inflation runs at 1.5% for 20 years, by 2037 the debt will still be worth £0.75 million in today’s money. But if inflation runs at an average of 3.5% - it will only be worth only £0.5 million in today’s money. Of course you are likely to have had to pay higher interest rates over that time, but at least the debt levels will be lower in today’s money terms. Higher inflation and a lowering Sterling value also are likely to mean property prices rising at a fast pace in future years.
UK Inflation History: One think is around 90% sure – that the UK will continue to have inflation since it’s the only way the government can every reduce its debts or devalue its debts. The UK has a strong “tradition” of inflation – normally running at around 1% per annum higher than mainland Europe – where monetary policy is set with a strong cautious German influence – they still recall Weimer German hyper-inflation and don’t want that to happen again.
House Price 67 Year History: If you look back at house prices, then you get a pretty good idea that future house prices will be far higher than today – simply because the Bank of England keeps printing money, creating inflation to make everyone be under the illusion that there is some form or growth. It’s like a massive con. But if you buy a house, this house will still be “one” house in 20 years time, but the value of Sterling may have dropped to half and house prices may have doubled.
So lets average UK house prices in the last 70 years:
Future Inflation: It’s very clear that currency continues to decline in value – and house prices in Sterling currency terms continue to rise. We just think this will continue in future years. It’s a UK speciality. So don’t be surprized if average house prices are £600,000 by 2030 or earlier. Particularly as the population is growing rapidly and levels of home building is lagging way behind demand. Only 190,000 new homes/units are being built or created each year though around 330,000 are needed just to keep pace with demand. On top of that, the supply-demand imbalance has been running at around 150,000 a year for the last 15 years – the UK is around 3 million new homes short.
More Dangerous: In summary – the world has just got a lot more dangerous – and expect oil prices to rise sharply end 2018 and in the meanwhile inflationary pressures will force the Bank of England to continue to raise interest rates – so make sure you have plenty in reserve to pay for higher tax bills from the new draconian buy-to-let taxes and also the higher interest rates expected – a massive double negative whammy for buy-to-let landlords.
Buy-to-Let Got Killed: We predict further buy-to-let investment slowdown through 2018 with an increasing rental crisis as not enough properties are available to meet demand – and landlords are also forced to increase rents to pay high tax bills plus the higher borrowing costs on top – particularly in London.
It’s all looking very stormy out there and many buy-to-let landlords are likely to go bust as the twin government induced pincers of higher borrowing costs severely compounded by higher buy-to-let taxes because of the interest rates increases – kick-in and eat all profits whilst property prices start to drop.
Taxes Just Too High – Tax on a Loss: It’s certainly worth considering whether you should sell up at this point – since the Government has ruined the business with their crazy taxes on business borrowing – landlords are being taxes on losses (not profits) – which is tantamount to purposely killing a business/market – something more akin to Venezuela than the UK. Only a reversal of Osbourne’s crazy tax grab will alleviate the pressures – particularly as interest rates rise.
We hope this Newsletter has given property investors some helpful insights and is preparing you for the next storm few years in the UK. If you have any queries please contact us on