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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).
Paul Dales Chief UK Economist
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UK Markets Chart Book

Markets too sanguine on interest rates

Our new forecasts that inflation will stay higher for longer and that the labour market will remain tight into 2023 suggests that Bank Rate will rise to a peak of 3.00% next year rather than the peak of 2.50% currently priced into the markets. As a result, we have revised up our forecasts for gilt yields. We now think the 10-year yield will rise from 1.84% to 3.00% by the middle of 2023. And in response to the prospect of weaker economic growth and higher interest rates, we have revised down our equity price forecasts. We expect the FTSE 100 to fall from 7,550 now to around 7,250 by the end of this year. Finally, this negative shift in investor sentiment partly explains why we have revised down our forecasts for the pound. We think the pound will weaken from $1.26 now to around $1.22 by December. UK Drop-In (Thurs. 5th May, 15:30 BST): Paul Dales and Ruth Gregory will be discussing our UK Economic Outlook, including our above-consensus call for UK interest rates, in a 20-minute online briefing after the May MPC meeting. Register now

29 April 2022

BoE Watch

Rates heading to 3.0% as MPC focuses on inflation concerns

The weakening economic outlook has deepened the dilemma facing the Monetary Policy Committee (MPC). But we think the MPC is sufficiently worried about rising price/wage expectations to raise Bank Rate from 0.75% to 1.00% on Thursday 5th May and to start shrinking the balance sheet quicker by selling gilts. Based on our forecast that the labour market will be tighter and that wage/price expectations will be more persistent, we expect the MPC to hike rates to 3.00% in 2023. That’s above the peak priced into the markets (2.50%) and the peak expected by a consensus of economists (2.00%). UK Drop-In (Thurs. 5th May, 15:30 BST): Paul Dales and Ruth Gregory will be discussing our UK Economic Outlook, including our above-consensus call for UK interest rates, in a 20-minute online briefing after the May MPC meeting. Register now

28 April 2022

UK Markets Chart Book

Financial conditions as tight as after the Brexit vote

The war in Ukraine has contributed to a tightening in financial conditions that will contribute to weaker GDP growth for the rest of this year and next year. Admittedly, a lot of the initial plunges in UK equity prices and gilt yields have been reversed. But the lasting financial market effects from the war in Ukraine so far appear to be higher commodity prices, higher interest rate expectations and wider corporate bond spreads. That’s why UK financial conditions have tightened to levels similar to those seen after the EU Referendum in 2016. While this will weigh on GDP growth this year and next, the tightening seen so far doesn’t pose a systemic risk.

29 March 2022

More from Paul Dales

UK Economic Outlook

Surge in inflation won’t be sustained

Our forecast that COVID-19 won’t significantly reduce potential supply means that the economy can run a bit hotter for longer without generating the persistent rise in inflation that would require monetary policy to be tightened. Admittedly, this won’t prevent the previous gains in commodity prices and component costs from triggering a rise in CPI inflation from 2.5% in June to around 4.0% by the end of the year. But it should mean that CPI inflation falls back below 2.0% in 2022 and the short-lived spike doesn’t lead to higher pay growth and inflation expectations. That’s why we think monetary policy won’t be tightened until the middle of 2023, which would be a year later than the markets expect.

20 July 2021

UK Data Response

Monthly GDP & International Trade (May)

The easing in the pace of the economic recovery in May suggests that GDP is now more likely to return to the February 2020 pre-pandemic peak in October rather than in August. The bigger point, though, is that the recovery so far has been faster than most imagined possible six or 12 months ago. And the economy may yet surprise most forecasters again by emerging from the pandemic without much scarring.

9 July 2021

UK Economics Update

CPI inflation may peak around 4%

Bigger rises in commodity and component costs than we had expected mean that we now think CPI inflation will rise from 2.1% in May to a peak of about 4.0% around the turn of the year. But we still think this will be a short, sharp spike in inflation that won’t feed into persistently faster pay growth or higher inflation expectations for a couple of years yet. As such, we suspect the Monetary Policy Committee will look through it and won’t tighten policy as soon mid-2022 as the financial markets expect.

6 July 2021
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