Aurelia Butler

UK government debt has delivered the worst returns of any major bond market in the first half of this year, as investors bet that the Bank of England will have to increase interest rates to the highest level in a quarter of a century to tame high inflation.An ICE Bank of America index of UK government bonds — known as gilts — has fallen by 3.7 per cent in the first half of 2023. Meanwhile, other big bond markets have delivered positive returns as inflation has eased and other central banks appear closer to the end of their cycle of rate rises.“Gilts have been a huge outlier this year, it’s been a very sobering experience,” said Jim Cielinski, global head of fixed income at Janus Henderson Investors. “You are seeing more of the traditional cost push inflation where wage pressures continue to move higher and higher.”The poor performance of gilts comes after investors had a major rethink about the outlook for UK interest rates, with wages and inflation data relentlessly exceeding market and economist expectations. UK headline inflation was 8.7 per cent for the year to the end of May, compared with 6.1 per cent in the eurozone and 4 per cent in the US.Retail investors and fund managers have been snapping up gilts in recent months to lock in some of the highest yields available since the global financial crisis. Nevertheless, two-year gilt yields hit 5.31 per cent on Friday, the highest level since 2007. But investors looking for short-term gains may be facing painful paper losses.Markets are now pricing in UK interest rates to rise from 5 per cent to a peak of about 6.25 per cent by the end of this year.While traders also expect more rate increases in Europe and the US, the moves are less stark, with markets pricing in a likely two more 0.25 percentage point increases by the ECB this year, and one more by the Fed in July. “UK inflation both headline and core has been much stickier than what the Bank of England or the market expected,” said Mohit Kumar, chief European financial economist at Jefferies, explaining why gilts had underperformed peers.He added that Andrew Bailey, BoE governor, sounded “surprised” by the persistence of inflation when talking on a panel at an ECB conference in Sintra, Portugal, this week, and that he sounded “uncertain” that inflation would come down quickly enough for the BoE to stop raising rates. Investors also note that the long-dated nature of the UK bond market and the large volume of debt being issued while the BoE has started selling gilts as part of its quantitative tightening programme have and will continue to weigh on performance. “The inflation and supply combination means gilts are still not quite there yet in terms of being attractive on a global market,” said Jon Day, fixed income portfolio manager at Newton Investment Management. “For global investors I would still say there are better markets out there than gilts.”Janus’s Cielinski said stagflationary fears are “noticeably higher” in the UK than in other markets, as the central bank feels like it has “no choice” but to keep clamping down on inflation, regardless of the pain that will be inflicted on large swaths of the economy.“You need to be tough but by being too tough and killing the economy and making it weaker than every other global economy — that is not a victory and it will come at such a cost that you will win the battle on inflation and lose the war,” he said. “I do think that is what the gilt market is saying.” More

When the chief executive of Next warned in March that surging inflation and stagnant sales would result in a “challenging” year ahead the City took notice.Shares in the high street bellwether fell almost 8 per cent following the profit warning and comments by Lord Simon Wolfson, who commands respect as the longest-serving boss in the FTSE 100.Yet three months on the picture appears very different: in June Lord Wolfson upgraded the retailer’s annual profit forecast, arguing that a combination of salary increases in April and warmer weather had encouraged shoppers to spend more on their summer wardrobes. The owner of Primark, one of the largest clothing retailers in Europe, followed suit with its own profit upgrade boosted by higher prices and strong demand for clothes. The more upbeat mood from two of the UK’s biggest clothing chains has confounded policymakers who have sought to tame resurgent inflation by lifting interest rates. Despite surging mortgage costs, greater energy costs and higher food prices, British retail sales unexpectedly expanded in May boosted by spending on summer clothing and outdoor goods, according to data published by the Office for National Statistics. Consumer confidence in the UK increased for the fifth month in a row last month despite “fierce economic headwinds”, according to research group GfK. But although the overall picture is one of people still treating themselves and swallowing the higher cost of non-essentials, within this there are winners and losers. Analysts are also asking how resilient household spending actually is amid stubbornly high inflation and as millions of homeowners find themselves squeezed by higher mortgage payments. “Yes, retail sales are holding up, but importantly, they are being driven by inflation, and actually, people are cutting back and they’re buying less,” said Richard Lim, chief executive of Retail Economics. He points to a wedge between the volume of products being sold and how much it costs to buy them — consumers are paying more and getting less in return, he explains. 

British retail sales grew more than expected in May, helped in part by better weather © Bloomberg

Nowhere is this starker than for the casual dining sector. Like-for-like sales at UK restaurants in May were up 2.7 per cent, compared with a year ago, according to data from CGA by NielsenIQ. Pub sales were 8.8 per cent ahead of last year. But high inflation means volume sales for both were below May 2022. Few restaurant bosses are more acutely aware of the challenges in the economy than Dean Challenger, Prezzo’s chief executive. Earlier this year, the Italian casual dining chain cut a third of its sites, let go of around 800 staff and entered a restructuring process just to stay afloat. Challenger said customers are making careful choices about when to splash out. Demand in peak trading periods, like the summer and winter holidays, had remained strong, but at the cost of making the quieter periods even more fallow. “People are being more careful in the quiet times, so they can enjoy the busier times and school holidays,” said Challenger. Two-fifths of consumers surveyed by CGA said they went out to eat and drink at least once a week in April — the figure was unchanged from March, but down two percentage points on October last year. Martin Williams, chief executive of Rare Restaurants which owns the Gaucho steak chain, is a mixture of bullish and cautious. He has been surprised by the level of demand at Gaucho’s latest 200-seater outpost in London’s Covent Garden district, with sales after just a fortnight already ahead of what was projected for six months. “It’s beyond what we imagined,” he said, but added: “It’s undoubtedly a tough time.” He predicts that the second half of the year will be more challenging. “Each interest rate rise chips away at disposable income, and that means less money to spend in restaurants.”Like rivals, Williams continues to have to manage high input costs — all the while wondering if robust consumer demand can continue to hold, as rising mortgage rates eat further into restaurant-goers’ disposable income. He has added more affordable £30 three-course lunch options to the menu as a result. Williams said sales in 2022 were up around 25 per cent on the pre-pandemic benchmark of 2019, but so far this year were flat compared with last year.There is evidence that higher end restaurants are more protected. Profit margins at the upmarket Ottolenghi chain are down just one percentage point year on year despite high inflation — and spending per head is up on last year, while dishes ordered per head is flat. “Probably the majority of our customers are in the cluster where if your mortgage payment goes up, you’re not happy but it doesn’t mean that you have to cut other expenses,” said Emilio Foa, chief executive. Mid-market restaurant chains are “suffering the most”, he added. Mid-market retailers are also “struggling” said Lim at Retail Economics. Several high profile brands such as Hunter and Joules have collapsed into administration over the past year. “They don’t have a strong enough proposition. They are still having to combat all of the costs and that squeezed [profit] margin is really hitting the middle part of the market where there’s much softer consumer demand,” he said. Although Next and Primark are both large chains, they have long been outliers in the troubled retail landscape and “don’t reflect the [wider] performance of the market” he added. Discounter B&M, which sells items spanning garden tools to frozen food, has benefited from hard-pressed consumers looking for bargains. “Clearly we’re seeing trading down to us,” said chief executive Alex Russo. Like-for-like sales for the three months to June 24 were up 9.2 per cent in the UK.

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But retailers selling more expensive big-ticket items, such as furniture and household appliances, have suffered. Bike and car parts seller Halfords saw profits tumble last year as the boom experienced during the Covid-19 pandemic ended. Finance chief Jo Hartley told investors in April that “it has never been harder to predict customer behaviour or cost inflation”. Customers are also leaning more on credit to afford technology, white goods retailer Currys said in May. “We’re still seeing consumers being very careful with their spending,” its chief executive Alex Baldock said. One clear winner among consumer spending is travel. Airlines are in the midst of a bumper summer season, with holidaymakers undeterred by the weak economic backdrop and sky-high ticket prices, which rose more than 30 per cent year-on-year across Europe in May.UK airline executives believe consumers are prioritising spending on holidays above other discretionary expenses, particularly after years of pandemic travel restrictions. British Airways owner IAG raised its annual profit forecast last month, as did low-cost carrier easyJet in April. “Of course, ‘revenge’ travel supported the recovery this year, but without restrictions and health concerns, people seem keen to resume flying more permanently, especially for leisure purposes and family visits,” said Rico Luman, a senior economist at ING.But the trend is for shorter trips: easyJet boss Johan Lundgren noted in a recent earnings update that people have booked briefer getaways this summer, with the average trip lasting seven days, down from nine last year.Still, there are early signs of a slowdown, with ticketing data showing a “progressive dampening” of demand since the beginning of April, according to Olivier Ponti, an executive at aviation data company ForwardKeys.Paul Charles, chief executive of travel consultancy the PC Agency, said despite the “bumper” summer for travel operators, he predicted that demand “will not continue at the same pace after the summer”. “Higher mortgage rates and prices across the economy will lead to some people tightening their belts, so I’d expect a September to December period which sees lower demand,” said Charles. “But at the higher, luxury end of the market the boom will continue.” More