Movements in the bond market suggest UK rate expectations are being dialled back
Thursday 14 Feb 2019 Author: Tom Sieber

As we write there seems little prospect of the fog of uncertainty created by Brexit clearing. This uncertainty appears to be the main culprit behind the UK economy contracting at the end of 2018 and against this backdrop investor expectations for an interest rate rise from the Bank of England any time soon are receding.

This has been reflected in falling yields and rising prices of UK Government bonds (also known as gilts). The market is clearly ignoring warnings from the Bank of England’s governor Mark Carney that rates might need to be hiked in a no-deal Brexit scenario to protect the value of the pound and are perhaps instead expecting a wave of bond-buying to stimulate the economy.

The latest UK GDP figures for December and the fourth quarter appeared to show businesses putting their investment plans on hold while they await some clarity on what shape the UK’s exit from the European Union might take. Investment dulled 0.5% quarter-on-quarter in the last three months of the year.

Growth in 2018 as a whole came in at 1.4%, down from 1.8% in 2017, the worst performance in six years.

In December the economy shrank month-on-month by 0.4%. However, consumer spending was stable, offering a glimmer of hope.

Howard Archer, chief economic advisor to the EY ITEM Club, an economic forecasting group, says: ‘Major uncertainty would likely be fuelled by a “no-deal” Brexit, negatively impacting business sentiment and investment, as well as affecting consumers. However, it must be remembered that consumer spending proved resilient in the aftermath of the June 2016 referendum vote.’

Prime Minister Theresa May updated parliament about Brexit negotiations on 12 February, saying she still believes it is possible to get a deal that MPs can support.

If no new legislation is introduced the UK will leave the EU on 29 March and around the beginning of February investment bank
Goldman Sachs increased its assessed chances of the UK crashing out without a deal from 10% to 15%.

Anything but a no-deal outcome could see a flood of investment and boost currently out-of-favour UK assets for which the best barometers are probably the pound, the FTSE 250 index and sectors such as housebuilding and banking.

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