DO UK INCOME INVESTMENTS OFFER GOOD VALUE?

03.08.2023 Today UK interest rates rose to a 15 year high of 5.25%. With inflation beginning to fall we look at whether UK income investments offer good value.

UK annual CPI inflation peaked at 11.1% in October 2022. However, it has been slow to reverse and by June 2023 was still 7.9%. Given the intense media focus on the Cost of Living crisis and the high British inflation rate it is useful to emphasise that the big picture, for the rest of the year, is that inflation will continue to trend downwards. A fall in the price of wholesale natural gas prices to below their level, prior to the outbreak of the war in Ukraine, will promote an ongoing moderation in energy price inflation. Food price inflation is also on its way down as the fall in food commodity prices on international markets, since the summer of 2022, has started to be reflected in the price of finished products in the supermarkets.  Indeed, the Institute of Grocery Distribution forecasts annual food price inflation to fall from a peak of 19% to between 8% and 10% by the end of the year.  Finally, inflation in the manufactured goods sector can also be expected to dissipate as supply chain disruption has now completely abated while the cost of raw materials and component inputs has tipped into deflation on an annual basis.

Income investments have had a rough time in 2023 because markets have begun to worry to that UK inflation will prove to be ‘sticky’. By this it is meant that inflation will get stuck at a rate well above the Bank of England’s inflation target and require very high interest rates to squeeze it out of the economy. Survey evidence suggests that in 2023 British salary growth has significantly outstripped that recorded in the United States and the Eurozone. This seems to reflect a tight labour market and a post Covid fall in workforce of about 1 percent due to early retirement and a rise in long term sickness. Wage settlements are currently running at around six percent and average hourly earnings are presently growing at around 7 percent. Nevertheless, this seems likely to represent a peak. As the economy tips into recession in the second half of the year market forces, driven by rising unemployment and a falling stock of job vacancies, are likely to gradually re-assert themselves. So, I would argue that inflation is unlikely to be sticky, but its descent is likely to be slow.

Currently UK markets are projecting peak interest rates of around 5.75%. This suggests that the stickiness of inflation has been at least partially priced in. With inflation on the way down, as food and energy inflation slow, and the UK labour market starting to turn a slow descent of inflation is the most likely outcome. As a result, UK income investments are attractively priced in my opinion.  For medium term investors there are plenty of good quality corporate bonds yielding over 5 percent. Furthermore, UK infrastructure shares yield between 5 and 6 percent while well run property companies, in non- cyclical sectors, offer even better value with yields of 6 to 7 percent available.

For information only. Investors should seek professional advice for their own circumstances before making an investment.

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This post was written by Robin