SUMMARY
The outlook for the UK economy seems distinctly unpromising to us for now. But with interest rates likely having peaked, certain UK government bonds may make sense for UK and European investors.
Economic activity closer to bottoming out – In the very short-term, real GDP is likely to remain close to zero. While a technical recession remains possible this winter if euro area GDP were to fall in 4Q-23, we doubt that it will be either deep or long, given the relative stability in three of our composite forward-looking indicators.
Monetary policy transmission dampens demand for loans – The ECB’s October bank lending survey showed that credit standards had tightened further across all loan categories and that demand for loans by firms and household had continued to decrease noticeably. Looking ahead, we would expect a positive credit impulse to signal some gains in economic activity.
Labour market softening to add to broadening disinflation signals – With employment expectations softening and the PMI survey’s composite measure of employment slipping into negative territory, the private sector is likely to continue shedding labour in coming quarters, which is likely to translate into a slower rate of growth in negotiated wages.
Central banks on hold at peak rates, rate cuts coming into focus by mid-24 – A further normalisation of inflation expectations is likely to be a necessary condition for such a scenario to materialize in the late spring or early summer of 2024. We agree with current market pricing that Bank Rate will probably start falling around the middle of 2024, and that Bank Rate would likely fall by around 75bp to 4.50% by the end of 2024.
Equity strategy – European ex-UK and Swiss equities exhibit strong positive performance 12 months after last Fed hike but show negative performance 12 months after last domestic central bank hike. UK equities display much less sensitivity to both Fed and BoE rate hiking cycle.
Fixed Income strategy – European and UK bond yields fall significantly, 12 months after the last rate hike by the ECB and BoE, respectively. Plenty of opportunities presenting itself in the European and UK bond market. This analysis continues to support our view that European and UK bonds are back and should be a source of potential solid return over the next 12-18 months
