Upside risks of the election outweigh downside risks

As the markets have not fully priced in the Conservatives winning the general election on 12th December and securing a Brexit deal, if that were to happen we suspect the pound would climb from $1.28 now to $1.35, 10-year gilt yields could rise from 0.76% now to 1.50% by the end of 2021 and domestically-focused equities would outperform the internationally-exposed FTSE 100. However, a surprise election victory for the Labour Party could result in the pound falling back to $1.25, gilt yields rising even further and equity prices declining. The common theme in both outcomes is that we think the markets are too complacent in expecting official interest rates to be no higher than 0.75% in a couple of years’ time.
Paul Dales Chief UK Economist
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UK Markets Outlook

Markets mistaken on when and how BoE will tighten

Our forecasts that the Bank of England won’t tighten monetary policy until much later than the markets expect and that when it does it will unwind some QE first (perhaps in 2024) before raising interest rates (perhaps in 2025) is consistent with the gilt yield curve steepening over the next couple of years. So while 2-year gilt yields will probably remain very low for a couple more years yet, 10-year yields may rise from 0.86% now to around 1.50% by the end of 2022. We suspect that the resulting drag on the future value of UK corporate earnings will be more than offset by the boost to earnings from a faster and fuller economic recovery than is widely expected. And given that the valuation of UK equities still appears attractive, there is scope for UK equities to rise more rapidly than equities in other major markets. Our forecast is that the FTSE 100 climbs from 7,000 now to around 8,250 by the end of 2022.

24 May 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

More from Paul Dales

UK Markets Outlook

Markets mistaken on when and how BoE will tighten

Our forecasts that the Bank of England won’t tighten monetary policy until much later than the markets expect and that when it does it will unwind some QE first (perhaps in 2024) before raising interest rates (perhaps in 2025) is consistent with the gilt yield curve steepening over the next couple of years. So while 2-year gilt yields will probably remain very low for a couple more years yet, 10-year yields may rise from 0.86% now to around 1.50% by the end of 2022. We suspect that the resulting drag on the future value of UK corporate earnings will be more than offset by the boost to earnings from a faster and fuller economic recovery than is widely expected. And given that the valuation of UK equities still appears attractive, there is scope for UK equities to rise more rapidly than equities in other major markets. Our forecast is that the FTSE 100 climbs from 7,000 now to around 8,250 by the end of 2022.

24 May 2021

UK Data Response

Retail Sales (Apr.)

The surge in retail sales volumes in April shows that households flooded back to the shops once they reopened in the middle of the month and suggests there is even some upside risk to our forecast that the economic recovery will be fast and full if households spend a big chunk of their lockdown savings.

21 May 2021

UK Economics Update

Burst of reopening inflation will probably be temporary

We suspect that a bout of inflation triggered by the economy reopening will be brief and that a more widespread and sustained rise in inflation that would concern the Monetary Policy Committee won’t happen until late in 2023.

11 May 2021
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