It is worth noting the all-in cost of debt is down now by about 175 bps since the peak seen after the mini budget and that is because the markets feel more secure.
The market expects base rates to increase a further 1-1.5% over the next 6-9 months as the Bank of England seeks to control inflation. This is evident from the forward curves, and is already priced into 3-5 year swap rates that underpin much of commercial and mortgage borrowing in the UK. Rates are expected to start reducing later in 2023, but there is a risk to the downside if inflation remains stubbornly high.
On the margin side, most lenders have already priced in the current economic climate, and I am not convinced margins are going to move much further. Banks have increased margins by around 25-50bps, particularly in sectors where sector limits have come under pressure as reduced M&A volumes slow down the rate of churn in loan books. There are concerns sectors that have had a favourable rating until now could be red flagged as credit committees seek to moderate the rate of loan book growth.
The position with debt funds is more complex. They have an ability to be more flexible and pragmatic, but that could lead to opportunistic pricing in certain sectors. We have seen pricing move 100bps wider in the last few months as funds have adjusted to the new environment and because they have found it hard to access back leverage over the summer and early autumn. That market has started to thaw in recent weeks, and we anticipate pricing could improve slightly as many non-bank lenders remain keen to deploy.
The biggest known unknown on rates is Ukraine. Being optimistic, if there was somehow a short-term resolution to the war, inflationary pressures would reduce, and future base rate increases could be avoided. But some commentators believe there is risk the war could escalate further and, in that scenario, all bets are off.