Buffeted by global forces

For the remainder of this year UK assets will probably be buffeted by global trends, resulting in UK equity prices falling by about 10%, 10-year gilt yields declining from 1.05% to around 1.00% and the pound weakening from $1.29 to about $1.25. But if a Brexit deal later this year allows UK economic growth to accelerate in 2020 and 2021, then domestic factors will probably take over as the main driver of UK asset prices. We suspect that by the end of 2021, UK equity prices will have regained all their losses and higher interest rates will have contributed to 10-year gilt yields rising to about 2.00% and the pound climbing to around $1.40.
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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

Emerging Markets Economics Update

EM easing cycles not all to do with the Fed

Financial markets have come round rapidly in the last few weeks to our view that EM monetary policy will be loosened further this year. But EM loosening cycles have much more to do with weak domestic growth and low inflation than the prospect of interest rate cuts in the US.

20 June 2019

European Economics Focus

Cyprus to outperform euro-zone, but risks remain

Cyprus has now recovered from the economic crisis of 2012-13, which was caused primarily by its oversized banking sector. While a number of risks remain, notably the high level of non-performing loans, we expect the economy to continue expanding more rapidly than the euro-zone as a whole for the next few years, and the public debt ratio to fall steadily.

20 June 2019

Emerging Europe Data Response

Russia Activity Data (May)

May’s activity data suggest that, following extremely weak GDP growth in Q1, Russia’s economy has failed to gather much momentum in Q2.

20 June 2019
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