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If you are a UK mortgage borrower I’d guess your ideal update on the state of the UK economy would be: interest rates are coming down (so your borrowing will be cheaper) and the economy is staying strong (so there will be plenty of buyers for your house). There was plenty of news on both sides of this out of the UK this week. The Bank of England cut rates on Wednesday but was overall more hawkish than the market had expected (two members voted against cutting) so the market now expects (slightly) higher interest rates going forward. On the growth side, the trade deals announced with the US and India are (again slightly) growth positive.
Given the small moves in both directions the market reaction to all this was muted. More important has been the steady drip-feed of progress on tariff talks out of the US. I wrote a couple of weeks ago about the moves we have seen this year out of US equities (USA vs Team Europe). This has left investors tactically underweight the US (see below the positioning data we receive from Vanda Research). The pain trade for equities (and particularly US equities) looks to be up:
But what of the UK looking forward? I continue to be optimistic that interest rates will keep coming down. On the goods side of the economy, oil is now back to pre-Covid prices (and of course around 30% cheaper when you adjust for inflation). Plus, fewer goods going from Asia to the US probably means (in the short term at least) more goods flowing into Europe at lower prices. Sterling strength will only add to goods deflation. I have a feeling garden furniture will be getting cheaper over the next few months.
The problem for the inflation story continues to be the services sector and its stubbornly high wages. Again, I think the picture should improve here. Survey data is pointing to slowing wage increases and the UK labour market is definitely softening. Payroll growth (which remains positive in the US) has turned negative here. The UK jobs market, while not in real trouble, isn’t looking too healthy today either.
Market pricing is for a terminal UK bank base rate of 3.5%, but I would expect it to be less and in line with Goldman Sachs, who are forecasting this will be 2.75%.
There are a couple of investment opportunities that drop out of this analysis. First, we continue to like gilts (and we remain overweight fixed income overall). If we are right that UK market pricing is a little too high then we should be able to make our 4.5% or so carry plus make some capital gains down the line. Secondly, the investment trust sector still trades at sizable discounts. Bank base rates below 3% should make the yields available on some of these trusts look attractive again. Continued bid activity is also helping here. We are continuing to look for opportunities to add to this sector.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
