Ketish Pothalingam, UK Credit Portfolio Manager and Peder Beck-Friis Portfolio Manager and Global Macro Analyst at PIMCO in London share their latest analysis of the United Kingdom after the election results and its implications on BoE monetary policy.
PIMCO´s portfolio managers believe the election result reduces uncertainty significantly but does not eliminate it. From an investment point of view, they find the British pound cheap compared to the US dollar and believe that British banks offer a better value compared to their European peers with similar ratings. They think that bad macro data flow could push the BoE more doveish.
The End of the Beginning
We have been expecting two rate cuts from the Bank of England (BoE) next year for some time. We assume they will wait until well into next year (May) to give time to see how the data evolve post-election. But two factors suggest risks of a more dovish policy meeting this week and earlier cuts. 1. The data flow has deteriorated with PMIs sub-50 and the CBI finding the largest fall in manufacturing output since 2009. These surveys may exaggerate the weakness but reaching BoE growth forecasts is getting challenging. 2. PM Johnson committing to not extend the Brexit transition period supports our base case for weak growth and suggests little reason for the BoE to become more optimistic about an investment rebound. Indeed, it might be a reason for more caution.
Rates: election elation stumbles on macro momentum
The sell-off in rates post-election was short-lived, with Gilts now 4bp richer versus last Thursday’s close. We had been recommending clients fade any post-election cheapening in rates but admit this has played out quicker than we were expecting. We do not see this week’s BoE meeting doing anything to reverse this trend, with poor macro data and headline inflation below target likely to support a dovish tone in this week’s minutes. We still see value in staying bullish UK rates heading into next year, both outright and cross-market, with the front end not pricing a full cut while we see potential for two in 2020.
GBP: Bubble burst
GBP/USD has erased all of its General election gains on reports that the government will attempt to legislate against an extension of the transition period beyond December 2020. We have been surprised by how quick the markets have been to readily assume that a sizeable majority would allow the Prime Minister to soften the edges of his Brexit plans. If anything, since the election, the PM has been keen to emphasize that the commitment to leave the transition phase by end-2020 is a manifesto pledge that he intends to adhere to. Ultimately (as with the October deadline), we think the UK will agree to some sort of deal with the EU, but the breadth and scale of that deal remain to be seen. In the meantime, a commitment to leave the EU transitional phase by end 2020 will do nothing to encourage confidence in the UK as an investment opportunity