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UK Markets

UK Economics Weekly

Too soon to conclude inflation won’t become more persistent

It’s too soon to conclude that the weak tone of this week’s news on activity means that inflation won’t become more persistent. Our proprietary measure of underlying/persistent CPI inflation rose to a new record high in May. And the flurry of higher pay settlements across the economy suggests that high inflation is feeding into faster wage growth. This may not necessarily be enough to prompt the Bank of England to start raising interest rates in 50 basis point steps. But we still think that rates will need to rise from 1.25% to 3.00% to tame inflation.

24 June 2022

UK Data Response

Retail Sales (May)

The fall in retail sales in May suggests that the decline in households’ real incomes from surging inflation is starting to hit consumer spending a bit harder. Even so, consumer spending appears to be softening rather than sinking, so we doubt that this will deter the Bank of England from hiking interest rates further.

24 June 2022

UK Markets Chart Book

Gilts to struggle sooner, equities to struggle for longer

We haven’t changed our forecast that the Bank of England will raise interest rates from 1.25% now to a peak of 3.00% by the middle of next year. But we do now think that a number of other central banks will raise interest rates faster and to higher levels to try and get on top of inflation. As a result of these global factors, we now think that 10-year gilt yields will rise from 2.35% currently to a peak of 3.00% by the end of this year rather than to 3.00% by the middle of next year. We also think the FTSE 100 will fall from 7,050 now to a trough of around 6,600 by the end of next year (rather than to a low of 6,800 by the middle of next year). In other words, rises in global interest rates and the toll they will take on activity will result in the prices of gilts falling faster and UK equity prices falling further and for longer.

23 June 2022

Key Forecasts

Main Economic & Market Forecasts*

%q/q(%y/y) unless stated

Latest

Q3 2020

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2020

2021

2022

GDP

+16.0(-8.6) Q3

+16.0(-8.6)

-3.1(-11.5)

-3.5(-11.9)

+6.0(+14.9)

+7.2(+6.2)

+1.7(+11.5)

(-10.8)

(+4.5)

(+8.8)

CPI inflation

(+0.3) (Nov)

(+0.6)

(+0.5)

(+0.6)

(+1.6)

(+1.7)

(+2.1)

(+0.9)

(+1.5)

(+1.7)

ILO unemployment rate (%)

4.9 (Oct)

4.8

5.2

5.5

5.9

6.5

6.5

4.5

6.1

5.6

Bank rate, end period (%)

0.10

0.10

0.10

0.10

0.10

0.10

0.10

0.10

0.10

0.10

10 yr gilt, end period (%)

0.29

0.25

0.24

0.30

0.35

0.40

0.50

0.24

0.50

0.50

$/£, end period

1.36

1.29

1.35

1.37

1.38

1.39

1.40

1.35

1.40

1.45

Euro/£, end period

1.11

1.14

1.13

1.12

1.12

1.12

1.12

1.13

1.12

1.12

Sources: Capital Economics, Refinitiv

* Assumes that severe COVID-19 restrictions are in place during January and February and that restrictions are eased very gradually in March, April, May and June. (See here.)


When will vaccines unlock the economy?

UK Economics Weekly

26 June 2022

Our view

Even though the UK economy is at risk of falling into a recession, the rise in CPI inflation to a 40-year high of 9.0% in April and other evidence that domestic price pressures are still strengthening support our view that the Bank of England will raise interest rates from 1.25% now to 3.00% next year. All this suggests that the prices of gilts and UK equities will fall further over the next year.

Latest Outlook

UK Markets Outlook

Stagflation stalking the markets

If we are right in expecting inflationary pressure to stay strong even as the economy gets dangerously close to a recession, then the prices of gilts and UK equities will probably fall further over the next year. Our forecast that the Bank of England will raise interest rates from 1.00% now to 3.00% next year would take rates above the peak of 2.50% priced into the markets and would therefore suggest that 10-year gilt yields will rise further than widely expected (perhaps from 1.90% to 3.00%) and that the FTSE 100 will fall further (perhaps from 7,500 to 6,800). The risk is that an even weaker economy prompts equity prices to fall further. And with inflation high, the markets can’t rely on the Bank of England to provide any relief.

26 May 2022