Economy and policy to provide a bit less support

The recent downward revision to our GDP growth forecasts and the recent hawkish signs from the Bank of England which prompted us to bring forward our forecast of when monetary policy will be tightened means the economic backdrop is a bit less conducive towards rapid gains in risky assets than we previously thought. Admittedly, we still think that the economic recovery will be healthier than most forecasters expect and that the Bank of England won’t tighten policy until a year after the mid-2022 date assumed by the financial markets. As such, we still expect the FTSE 100 to gain some ground on the S&P 500 over the next couple of years. And we think that by rising only modestly from about 0.60% now to 1.25% by the end of 2023, 10-year gilt yields will increase by less than 10-year US Treasury yields.
Paul Dales Chief UK Economist
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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 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

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Inflation expectations – what to watch

The inflation expectations of households, businesses and the financial markets will probably rise in the coming months as actual CPI inflation jumps to over 4.0% later this year. But as the rises are most likely to be confined to measures that capture expectations over the next 12 months rather than over the next 5-10 years, we doubt the Bank of England will respond by raising interest rates this year or next.

25 August 2021

UK Economics Chart Book

Recovery becoming more tepid

With a whopping 1.0 million people on average having been asked by the NHS App or Test & Trace system to self-isolate in July, the “pingdemic” is likely to have stifled the economic recovery in recent months. In July, our Capital Economics BICS Indicator suggests that GDP did not rise much. But new virus cases have fallen substantially since mid-July and there are signs that the full vaccination of 75% of all adults has weakened the link between COVID-19 cases and hospitalisations. So we still think the economy will make good headway in Q3 and that monthly GDP will return to its pre-virus February 2020 level in October. However, it’s possible that virus cases start to climb again, which at some point could prompt the government to become worried about hospital capacity and respond by reimposing restrictions. That remains the biggest downside risk to our economic forecasts.

11 August 2021

UK Economics Update

Inflation expectations & pay growth key to policy tightening

A bumper rise in utilities prices in October could contribute to CPI inflation climbing to a 10-year high of 4.4% in November. But as we don’t expect higher CPI inflation to feed through into higher inflation expectations or faster underlying pay growth, we doubt the Bank of England will respond by tightening monetary policy until things change in 2023.  

3 August 2021
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