The latest BoE comments have shifted market perceptions towards an imminent rate hike. Beyond the interest rate increase on November 2nd, market expectations of further hikes are nonetheless limited. Withdrawing some of last year’s emergency easing clearly makes sense in a context of above-trend global growth. And in the light of PM May’s speech in Florence, a smooth Brexit transition appears now more likely, easing fears of a sharp domestic downturn. There are three implications for UK assets.
The primary impact can be seen on the exchange rate. As the BoE communicated on its desire to start withdrawing Brexit emergency easing, the British Pound has become more attractive. In our view, an outright short GBP is not warranted in this context. We note that open short GBP positions have been scaled-back towards almost neutral in the derivatives markets, a first since the Brexit vote. A more positive view on the GBP would require the BoE to communicate clearly on its potential tightening cycle.
As a consequence, UK equities are likely to be impacted. A strengthening currency weighs on future earnings expectations through the repatriation of overseas profits. Our model shows that 12-month forward profit growth could fall towards low single- digits by the end of the year. Hence, Candriam remains underweight on Europe ex-EMU as UK equities could continue their underperformance vs continental Europe in local currencies. In addition, there is now less potential for big caps to outperform small caps in the UK.
Finally, Gilt yields face upward pressure in this context and have already jumped by 40bps in one month. A more hawkish monetary cycle than expected (and certainly relative to the ECB), above-target inflation to persist in 2018 (Candriam expects 2.5% CPI next year) and a less dovish growth context thanks to supportive global growth and a softer Brexit transition: many factors are in place to potentially see continued upward pressure on UK bond yields.