When we produced our forecasts for 2020 back in early December, we knew that our UK outlook was the one with the most scope both for volatility and for being wrong.
We still had the election ahead of us, an uncertain path towards Brexit, an even more ambitious journey towards a trade deal with Europe and of course a stagnating economy. The uncertainty around all of these was weighing very heavily on both business and consumer sentiment in the UK, at a time when the economy least needed it after a year of synchronised global economic slowdown.
We expected the data from the period preceding the election to be particularly weak, but we had to take a view on the political event to have a base case forecast. Like many, we took the view that the Conservatives would win a majority and would be able to push the Withdrawal Agreement legislation through parliament. The future UK-EU trade deal would be another matter.
We also predicted a post-election knee-jerk rally in sterling, which in our view had been oversold; the more stable currency and the removal of some uncertainty would see some of the Brexit premium in sterling assets removed. We thought sterling would be the best performing reserve currency for 2020, that sterling credit spreads would outperform both their dollar and euro equivalents, but Gilts would be the worst performing of the ‘risk free’ government bond complex.
We saw the Bank of England’s Monetary Policy Committee (MPC) would keep monetary policy on hold for the whole year. Our rationale was, and still is, that the UK has faced trade uncertainty ever since the nation elected to withdraw from the EU in the 2016 referendum. Business capex had ground to halt, and rightly so – why would businesses invest in the way they would normally expect while the UK’s future trading relationship with the EU was yet to be decided?
Had it not been for the referendum, we could have expected the UK economy to perform much closer to that of the US, where the Federal Reserve managed to put through eight rate hikes after the Brexit referendum, albeit reversed with three cuts in 2019. So now with some of the trade uncertainty removed, a stable government and a less volatile currency, we expected a bounce in UK economic activity and a gradual return of the missing business capex as the ‘animal spirits’ of the country’s entrepreneurial culture re-emerged. From a rates perspective, we thought the MPC would wait for concrete evidence that this investment was returning before eventually hiking rates in 2021.
Having got the difficult part correct, which was the political view, we now find ourselves scratching our heads as to why BoE governor Mark Carney, and MPC members Gertjan Vlieghe and Silvana Tenreyo, have all decided to come out with very dovish comments ahead of next week’s policy meeting.
Markets were clearly not expecting these and have had to readjust to the more balanced chances of a rate cut next week; Gilts have rallied and sterling has taken a breather. Carney, Vlieghe and Tenreyo all cited the obvious fact that the data preceding the election was particularly poor and could warrant more monetary assistance. But why make this comment if they had no intention of cutting rates? It creates unnecessary volatility, in our view, when the mandate is stability.
The few data points that cover activity since the election have shown a sharp bounce. Yesterday’s CBI data was perhaps the most significant so far, with the move from minus 44 to +23 being the biggest ever quarterly swing since the survey began in 1958. All eyes now will on tomorrow’s PMI data, where the consensus is around a print of 50.7, up from December’s 49.3. One interesting statistic is there has never been a rate cut after a PMI reading of 51.5 or higher. We then have the UK budget in March which is expected to showcase some form of fiscal stimulus.
Why would the MPC not want to just wait and see? A rate cut now makes very little sense to us, and wastes one of the few bullets the BoE has left in its armoury. If they do decide to cut next week, we think it will be reversed within 12 months. If there is no cut, then why talk to the market in this way? Could the new governor be a more reliable boyfriend?