Stagflation stalking the markets

If we are right in expecting inflationary pressure to stay strong even as the economy gets dangerously close to a recession, then the prices of gilts and UK equities will probably fall further over the next year. Our forecast that the Bank of England will raise interest rates from 1.00% now to 3.00% next year would take rates above the peak of 2.50% priced into the markets and would therefore suggest that 10-year gilt yields will rise further than widely expected (perhaps from 1.90% to 3.00%) and that the FTSE 100 will fall further (perhaps from 7,500 to 6,800). The risk is that an even weaker economy prompts equity prices to fall further. And with inflation high, the markets can’t rely on the Bank of England to provide any relief.