UK Markets

UK Markets Chart Book

UK Markets Chart Book

Investors spooked by Omicron risks

The discovery of the Omicron COVID-19 variant in late November rattled UK markets. Equities tumbled, sterling weakened and corporate credit spreads jumped. And, while the initial reaction was not unique to the UK, it does seem that investors remain a bit more downbeat on the UK’s prospects relative to elsewhere. Compared to the US and euro-zone, credit spreads remain higher, sterling is still weaker, government bond yields have fallen further and the downward shift in investors’ interest rate expectations has been striking. Admittedly, equities have more-or-less recovered in line with other major benchmarks, but that seems mainly due to global factors pushing up the internationally-focused FTSE 100. For our part, we agree with investors that the UK’s near-term outlook looks fairly gloomy. In fact, we expect GDP to contract by 0.1% m/m in December, and the risks to even that subdued forecast are on the downside. But where we differ from investors is in our view of the likely pace of interest rate hikes by the Bank of England. We expect Bank Rate to reach 0.50% by end-2022, well below the 1.00% currently discounted in markets. Note: Central Bank Drop-In – The Fed, ECB and BoE are just some of the key central bank decisions expected in this packed week of meetings. Neil Shearing and a special panel of our chief economists will sift through the outcomes on Thursday, 16th December at 11:00 ET/16:00 GMT and discuss the monetary policy outlook for 2022.

15 December 2021

UK Markets Chart Book

Investors overestimating interest rate hikes

The extent of the shift in investors’ expectations of interest rates over the past month has been staggering. Investors are now pricing in an 80% chance of a hike to Bank Rate, from 0.10% to 0.25%, at the Monetary Policy Committee (MPC) meeting on 4th And a further rise to 0.50% is now fully discounted in markets by the meeting on 3rd February. We agree with investors that an interest rate hike in the next few months looks increasingly likely. But, in our view, the extent of tightening that investors have priced in looks wide of the mark. Instead, we expect the Bank of England to hike rates gradually and by less than most expect. That’s based on our forecast that economic activity will be soft over the next few months, and that CPI inflation will peak just shy of 5% in April 2022 and fall back sharply thereafter.

22 October 2021

UK Markets Chart Book

Worrying more about higher inflation

The recent rises in 2-year and 10-year gilt yields to their highest levels since the “dash for cash” at the start of the pandemic have entirely been driven by the investors revising up their expectations for inflation. Indeed, 10-year break-even inflation rates are now at their highest level since the Global Financial Crisis (GFC). Our forecast that RPI inflation will shoot up from 3.8% in August to just over 6.0% by the end of the year suggests that break-even inflation rates may yet rise further. But they should then drop back next year as the bulk of the rise in RPI inflation is reversed. What’s more, our view that the Bank of England will put more weight on the recent weakening in activity than the rise in inflation and won’t raise Bank Rate until 2023 suggests that a big surge in nominal gilt yields is not around the corner.

21 September 2021
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UK Markets Chart Book

Markets to regain their poise as recoveries continue

While the resurgence in COVID-19 cases that has recently weighted on UK equities, the pound and 10-year gilt yields is clearly a downside risk, our view that it won’t deal a big blow to the global or domestic economic recoveries suggests that UK equities, the pound and 10-year gilt yields will all continue their latest rebound. That said, we have revised down our financial market forecasts. We no longer expect the pound to significantly strengthen or UK equities to drastically outperform overseas equities. And because we think the Bank of England will tighten monetary policy later than the financial markets assume, we now expect 10-year gilt yields to rise from close to 0.60% now to only 0.75% by the end of this year, to 1.00% next year and to 1.25% in 2023 (down from 1.25%, 1.50% and 1.50% previously).

22 July 2021

UK Markets Chart Book

Markets expect earlier rate hikes to quash inflation

The combination of the Fed’s more hawkish tone and the larger-than-expected rise in UK CPI inflation in May to 2.1% has led the financial markets to bring forward their expectations of when the Bank of England will raise interest rates from around the end of 2022 to shortly after the middle of 2022. Our forecast that inflation will fall back below 2.0% next year suggests that policy won’t be tightened until later, perhaps not until 2024. What’s more, when the Bank does start to tighten policy, we think it will unwind some quantitative easing first before raising interest rates, perhaps in 2025. This suggests there is scope for market rate expectations to fall back and the recent flattening of the gilt yield curve to be reversed. We are hosting a Drop-In at 1400 BST/0900 ET on Thursday 24th June shortly after the MPC meeting to discuss if the Bank of England will soon follow the Fed by signalling a willingness to bring forward the withdrawal of policy support. You can register here.

23 June 2021

UK Markets Chart Book

Rapid economic recovery to support equities

Our view that the economy’s recovery from the COVID-19 crisis will be faster and fuller than most expect is consistent with UK equity prices continuing to rise over the next couple of years. Admittedly, UK equities have lagged their international counterparts since the pandemic. The FTSE 250 only rose back to its pre-pandemic level earlier this month and the FTSE 100 is still 9% below it. But the composition of the UK’s equity indices means that they should benefit by more than others from the economic recovery. As such, the gap between UK and international equities may narrow over the next couple of years.

22 April 2021

UK Markets Chart Book

Pricing in higher inflation and interest rates

The jump in 10-year gilt yields from 0.29% at the end of January to 0.76% now has been driven by the markets pricing in a rise in inflation after the pandemic that they think will eventually prompt the Bank of England to raise interest rates sharply. With the Bank having done a fairly good job of anchoring short yields, the yield curve has steepened. We think this trend has further to run. Admittedly, we are not convinced that the Bank will end up raising interest rates sharply. But we do think that inflation will be persistently above 2% from 2023, if not before. As such, we have revised up our 10-year yield forecasts to 1.25% by the end of this year and to 1.50% by the end of next year.

24 March 2021

UK Markets Chart Book

Inflation expectations unlikely to lift gilt yields much

10-year gilt yields haven’t been significantly dragged higher by 10-year US Treasury yields because, unlike their US counterparts, break-even inflation rates in the UK have not been boosted by expectations of a big fiscal stimulus, a rise in inflation and tighter monetary policy. Admittedly, we suspect that diminishing expectations of negative interest rates in the UK will push up 10-year gilt yields from 0.28% now to around 0.50% by the end of the year. But our relatively subdued forecast for RPI inflation over the next two years suggests that the markets’ inflation expectations won’t push up 10-year gilt yields much further. Our forecast that 10-year yields will end 2022 at 0.50% is lower than the consensus forecast of 0.80%. Global State of Play, 28th January, 0800 GMT and 1600 GMT. In the first of our regular briefings of the year, Group Chief Economist Neil Shearing will lead a discussion about the economic impact of vaccination programmes, another US fiscal stimulus package and fresh lockdowns in China.

27 January 2021
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