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Good morning. On the plus side, eggs are back on the menu. US producer price index data out yesterday showed prices of chicken eggs have fallen 50 per cent over the past year. That’s clucking great news for American politicians who have been seemingly obsessed with this issue for months. Sadly, the rest of the wholesale inflation data is harder to swallow, with the index up 6 per cent year-on-year, posting the biggest monthly jump since March 2022. Unsurprisingly, fuel played a big part. Is this the start of the Iran-related inflation wave? Send us your thoughts: [email protected].
Today, me on the UK mortgage market and monetary policy, and Hakyung on US oil producers.
The UK’s mortgage market has changed. So have the lags
Central banks are in a tricky spot. The first effects of the energy shock are starting to hit the global economy, and they need to take a view on whether to look past the shock, or raise interest rates to bring inflation back to target. One reason this is hard is that no one really knows how long it takes for policy changes to take effect.
Markets react to policy news almost instantly, of course. And in deep and liquid markets, expectations of rate changes are priced into borrowing costs for bonds and loans, and in exchange rates, well in advance of any actual rate change. So, some argue lags are pretty short.
But the time it takes for a rate change to transmit to consumption and inflation can be much longer. Views on exactly how long are surprisingly diverse, but it’s pretty standard to assume a delay of 18 to 24 months. These are the famous “long and variable” lags that make central bankers reluctant to respond to one-off data surprises.
The lags have probably stretched out over the past decade or so. A major reason for this is changes in the structure of the mortgage market, particularly in the UK, which has flipped from a largely floating-rate model before the financial crisis to an almost entirely fixed-rate system today.
In a way, that leaves the UK mortgage market looking more similar to the US model, where fixed-rate mortgages have held above 90 per cent of the market for decades. The UK lags far behind the US, with its (quite odd) fondness for 30-year deals, but two- or five-year fixes can still delay how long it takes for households to cut back spending.
Sanjay Raja at Deutsche Bank broke the numbers down:
So what does this mean for policymakers? Well, last time the UK hit a tightening cycle, mortgage refinancing played a significant role in damping demand. Households that took out two-year fixed-rate mortgages at 2 per cent or so in 2020 were lumped with refinancing at 5 per cent in 2022. This time around, the step-up will be much less severe. Raja again:
Given the historical timing of the mortgage take-up, we estimate that the total cost of higher interest rates this year will amount to £4bn — well below the levels seen in 2023 and 2024. In fact, relative to the peak (quarterly cost), we don’t expect a meaningful increase until the second half of this year. And it’s not until 2027, where we see the bulk of the remaining five-year mortgage rates still on sub-2 per cent rates refinance towards 4 per cent-plus.
If policymakers really want to act, they’ll need to do it soon or risk missing the moment.
(Daire MacFadden)
Why not more drilling?
Despite the global energy shock, US oil companies haven’t seized the opportunity to drill more. According to Baker Hughes data, US rig count has barely moved in recent weeks and actually has fallen since the same period last year.
Several reasons exist for why the oil producers are hesitant to significantly expand drilling. Uncertainty from the Iran war is a big factor; you can drive a bus through the guesstimates for where crude prices will end up. The Dallas Fed survey for the first quarter of 2026 showed the forecast for oil prices at the end of this year now ranges between $50 and $135 per barrel. At the end of last year, the range was much tighter for the end of 2026 — between $50 and $82 per barrel.
Another block on boosting production is that major oil companies are focusing on profits over new drilling, which would require big capex decisions.
Some big energy names, most notably Diamondback, have suggested in the latest earnings cycle that they’re willing to raise production. Ultimately, the decision on whether to drill more will come down to what the oil futures curve indicates, and for now, it shows future oil prices lower than spot prices.
Dominic White at Absolute Strategy Research got in touch to say he’s “doubtful” that producers will rise to the bait. “Investment in the sector has become less responsive to higher prices in recent years, presumably as producers have prioritised the return of capital to investors,” he said.
Contrary to widespread assumptions, he also doubts the US can avoid a serious economic hit from the energy shock. He points to the relatively higher energy intensity of the US economy (we drew up a global comparison recently here), and adds that the second-order effects from more expensive oil, petrol and petroleum products may be larger than the direct effects:
“Petroleum and coal products” and “oil and gas extraction” as the two most latently significant products, meaning fluctuations in their prices have disproportionate indirect effects on other products — particularly things like transport, chemicals and food production . . . Putting the direct and indirect effects together, it’s reasonable to think the shock will add roughly one-and-a-half percentage points to inflation if it persists.
That would leave consumers with a real pinch on income growth. All in all, he concludes, “the hit to growth could be broadly comparable to that in Europe and Japan”. Now that would be a curveball.
(Hakyung Kim)
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