A fork in the road

The recent political chaos in Westminster means that the chances of the UK leaving the EU without a deal have risen, in our view, to about 50/50. In a no deal Brexit scenario, we would expect sterling to dip – although there are reasons to think that the fall would not be too big. Meanwhile, gilt yields would drop amid a “flight to safety” and expectations that interest rates would be cut. If, on the other hand, a Brexit deal is ratified in Parliament, then we still think that rates will rise at a faster pace than markets and most forecasters expect, paving the way for a rebound in sterling to $1.45/£ and around €1.20/£, and for a rise in the 10-year gilt yield to 2.25% by the end of 2019.
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More from UK Markets

UK Markets Outlook

Markets mistaken on speed of rate hikes

Although the economic backdrop has recently become less favourable for UK asset prices, we expect that the economic recovery will regain some vigour in the second half of next year, that CPI inflation will fall close to the 2.0% target in late 2022 and that over the next two years the Bank of England won’t raise interest rates as fast or as far as investors expect. As a result, we expect 10-year gilt yields to rise from close to 0.90% now to only 1.50% by the end of 2023 and we think the FTSE 100 will climb from around 7,225 now to 8,000 by the end of 2023. Relative to our US forecasts, the rise in bond yields is smaller and the increase in equity prices is larger. That said, we are not expecting the pound to strengthen against either the dollar or the euro. In fact, the risk is that it weakens against both.

22 November 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

More from Capital Economics Economist

Japan Economics Weekly

Post-Olympics public spending boost, BoJ holding firm

Japan’s government appears to be lining up a stimulus programme to prevent an economic downturn after the Tokyo Olympics next year. While increased public spending would provide a welcome boost to GDP, we don’t believe there’s any particular reason to expect a post-Olympics slowdown. Meanwhile, the Bank of Japan is bucking the global trend towards additional monetary easing. Unlike some commentators, we don’t think that loosening by other major central banks puts the Bank of Japan’s policy framework under pressure.

21 June 2019

Emerging Markets Economics Chart Book

EM growth running at a three-year low

EM GDP growth slowed to just 3.3% y/y in Q1, its weakest pace since the first half of 2016, and our Tracker suggests that it remained sluggish in Q2. Growth should pick up a little in the second half of the year. Large commodity producers, such as Brazil, Russia and South Africa, are likely to find their feet again after a terrible performance in Q1. And Turkey and Argentina should recover from the downturns caused by last year’s currency crises. But growth will remain weak and, in most cases, our 2019 and 2020 GDP growth forecasts are below consensus.

21 June 2019

Emerging Asia Economics Weekly

Growth continues to weaken, rates to be cut further

After a very weak first quarter that saw GDP growth in many countries drop to a post-financial crisis low, the most recent data suggest growth across Emerging Asia has continued to slow. Weak growth is likely to prompt further interest rate cuts over the coming months across the region. Despite leaving rates unchanged on Thursday, we expect the central banks of the Philippines and Indonesia to loosen monetary policy at their next meetings.

21 June 2019
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