TMS-AIS 2025-26 Appendices 1&2
Argyll and Bute Council · 27 February 2025
Back to Argyll and Bute Council — 27 February 2025 and its agenda
Text extracted from the council's PDF. Layout and reading order may differ from the original.
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APPENDIX 1 ECONOMIC BACKGROUND (to 12th December 2024) The third quarter of 2024 (July to September) saw: • GDP growth stagnating in July following downwardly revised Q2 figures (0.5% q/q) • A further easing in wage growth as the headline 3myy rate (including bonuses) fell from 4.6% in June to 4.0% in July; • CPI inflation hitting its target in June before edging above it to 2.2% in July and August; • Core CPI inflation increasing from 3.3% in July to 3.6% in August; • The Bank of England initiating its easing cycle by lowering interest rates from 5.25% to 5.0% in August and holding them steady in its September meeting; • 10-year gilt yields falling to 4.0% in September. Over the aforementioned period, the economy’s stagnation in June and July pointed more to a mild slowdown in UK GDP growth than a sudden drop back into a recession. However, in the interim period, to 12 December, arguably the biggest impact on the economy’s performance has been the negative market sentiment in respect of the fallout from the Chancellor’s Budget on 30 October. If we reflect on the 30 October Budget, our central case is that those policy announcements will prove to be inflationary, at least in the near-term. The Office for Budgetary Responsibility and the Bank of England concur with that view. The latter have the CPI measure of inflation hitting 2.5% y/y by the end of 2024 and staying sticky until at least 2026. The Bank forecasts CPI to be elevated at 2.7% y/y (Q4 2025) before dropping back to sub-2% in 2027. Nonetheless, since the Budget, the October inflation print has shown the CPI measure of inflation bouncing up to 2.3% y/y with the prospect that it will be close to 3% by the end of the year before falling back slowly through 2025. The RPI measure has also increased significantly to 3.4% y/y. How high inflation goes will primarily be determined by several key factors. First amongst those is that the major investment in the public sector, according to the Bank of England, will lift UK real GDP to 1.7% in 2025 before growth moderates in 2026 and 2027. The debate around whether the Government’s policies lead to a material uptick in growth primarily focus on the logistics of fast-tracking planning permissions, identifying sufficient skilled labour to undertake a resurgence in building, and an increase in the employee participation rate within the economy. There are inherent risks to all the above. The worst-case scenario would see systemic blockages of planning permissions and the inability to identify and resource the additional workforce required to deliver large-scale IT, housing and infrastructure projects. This would lead to upside risks to inflation, an increased prospect of further Government borrowing & tax rises in the June
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2025 Spending Review (pushed back from the end of March), and a tepid GDP performance. Regarding having a sufficiently large pool of flexible and healthy workers, the initial outlook does not look bright. Research from Capital Economics has alluded to an increase of some 500,000 construction workers being needed to provide any chance of the Government hitting its target of 300,000 new homes being built in each of the next five years (234,000 net additional dwellings in England in 2022/23). But the last time such an increase was needed, and construction employment is currently at a nine-year low, it took 12 years to get there (1996 to 2008). Also note, as of October 2024, job vacancies in the construction sector were still higher than at any time in the 20 years preceding the pandemic. Currently, it also seems likely that net inward migration is set to fall, so there is likely to be a smaller pool of migrant workers available who, in the past, have filled the requirement for construction worker demand. The Government plans to heavily promote training schemes, particularly to the one million 16- to 24- year-olds who are neither in education nor work. But it is arguable as to whether the employee shortfall can be made up from this source in the requisite time, even if more do enter the workforce. Against, this backdrop, there may be a near-term boost to inflation caused by a wave of public sector cash chasing the same construction providers over the course of the next year or so, whilst wages remain higher than the Bank currently forecasts because of general labour shortages, including in social care where Government accepts there is a 150,000 shortfall at present. Unemployment stands at a low 4.3% (September), whilst wages are rising at 4.3% y/y (including bonuses) and 4.8% (excluding bonuses). The Bank would ideally like to see further wage moderation to underpin any further gradual relaxing of monetary policy. Indeed, over the next six months, the market is currently only pricing in Bank Rate reductions in February and May – which would see Bank Rate fall to 4.25% - but further cuts, thereafter, are highly likely to be even more data-dependent. If we focus on borrowing, a term we are likely to hear throughout 2025 is “bond vigilante”. Essentially, this represents a generic term for when the market is ill at ease with the level of government borrowing and demands a higher return for holding debt issuance. In the UK, we do not need to go back too far to recall the negative market reaction to the Truss/Kwarteng budget of 2022. But long- term borrowing rates have already gradually moved back to those levels since their recent low point in the middle of September 2024. Of course, the UK is not alone in this respect. Concerns prevail as to what the size of the budget deficit will be in the US, following the election of Donald Trump as President, and in France there are on-going struggles to form a government to address a large budget deficit problem too. Throw into the mix the uncertain outcome to German elections, and there is plenty of bond investor concern to be seen. Staying with the US, Donald Trump’s victory paves the way for the introduction/extension of tariffs that could prove inflationary whilst the same
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could be said of further tax cuts. Invariably the direction of US Treasury yields in reaction to his core policies will, in all probability, impact UK gilt yields. So, there are domestic and international factors that could impact PWLB rates whilst, as a general comment, geo-political risks continue to abound in Europe, the Middle East and Asia. In the past month, the US Core CPI measure of inflation has indicated that inflation is still a concern (3.3% y/y, 0.3% m/m), as has the November Producer Prices Data (up 3.0 y/y v a market estimate of 2.6% y/y, 0.4% m/m v an estimate of 0.2% m/m) albeit probably insufficient to deter the FOMC from cutting US rates a further 0.25% at its December meeting. However, with Trump’s inauguration as President being held on 20 January, further rate reductions and their timing will very much be determined by his policy announcements and their implications for both inflation and Treasury issuance. Looking at gilt movements in the first half of 2024/25, and you will note the 10- year gilt yield declined from 4.32% in May to 4.02% in August as the Bank’s August rate cut signalled the start of its loosening cycle. More recently, however, 10 year gilt yields have spiked back up to 4.35%. The FTSE 100 reached a peak of 8,380 in the third quarter of 2024 (currently 8.304), but its performance is firmly in the shade of the US S&P500, which has breached the 6,000 threshold on several occasions recently, delivering returns upwards of 25% y/y. The catalyst for any further rally (or not) is likely to be the breadth of AI’s impact on business growth and performance. MPC meetings: 9 May, 20 June, 1 August, 19 September, 7 November 2024 • On 9 May, the Bank of England’s Monetary Policy Committee (MPC) voted 7-2 to keep Bank Rate at 5.25%. This outcome was repeated on 20th June. • However, by the time of the August meeting, there was a 5-4 vote in place for rates to be cut by 25bps to 5%. However, subsequent speeches from MPC members have supported Governor Bailey’s tone with its emphasis on “gradual” reductions over time. • Markets thought there may be an outside chance of a further Bank Rate reduction in September, following the 50bps cut by the FOMC, but this came to nothing. • On 7 November, Bank Rate was cut by 0.25% to 4.75%. The vote was 8-1 in favour of the cut but the language used by the MPC emphasised “gradual” reductions would be the way ahead with an emphasis on the inflation and employment data releases, as well as geo-political events. In the following chart, despite a considerable gilt market rally in mid-September, rates started and finished the six-month period under review in broadly the same position.
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PWLB RATES 02.04.24 - 30.09.24 HIGH/LOW/AVERAGE PWLB RATES FOR 02.04.24 – 30.09.24 3.00 3.40 3.80 4.20 4.60 5.00 5.40 5.80 6.20 6.60 7.00 PWLB Certainty Rate Variations 2.4.24 to 30.9.24 2-Apr-24 30-Sep-24 Average 1 Year 5 Year 10 Year 25 Year 50 Year 02/04/2024 5.39% 4.72% 4.80% 5.28% 5.07% 30/09/2024 4.95% 4.55% 4.79% 5.33% 5.13% Low 4.78% 4.31% 4.52% 5.08% 4.88% Low date 17/09/2024 17/09/2024 17/09/2024 17/09/2024 17/09/2024 High 5.61% 5.14% 5.18% 5.61% 5.40% High date 29/05/2024 01/05/2024 01/05/2024 01/05/2024 01/05/2024 Average 5.21% 4.76% 4.88% 5.35% 5.14% Spread 0.83% 0.83% 0.66% 0.53% 0.52%
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APPENDIX 2 Approved Sources of Long and Short-term Borrowing On Balance Sheet Fixed Variable PWLB • • UK Municipal Bond Agency • • Local Authorities • • Banks • • Pension Funds • • Insurance Companies • • UK National Wealth Fund • • Market (long-term) • • Market (temporary) • • Market (LOBOs) • • Stock Issues • • Local Temporary • • Local Bonds • Local Authority Bills • • Overdraft • Negotiable Bonds • • Internal (capital receipts & revenue balances) • • Commercial Paper • Medium Term Notes • Finance Leases • •