Hawks Start Circling

By Alan Higgins, Chief Investment Officer, UK at Coutts

Economics | Hawks start circling

In an interview last week Martin Weale, a member of the Bank of England’s (BoE’s) rate-setting Monetary Policy Committee, said a spring 2015 rise was the “most likely path” for UK interest rates.

However, there needs to be a good reason for a central bank to countenance raising interest rates directly ahead of an election, particularly given the mixed outlook for UK inflation. Although the headline rate for January fell to 1.9%, output prices rose faster than expected.

As a result, we haven’t changed our view of the likely trajectory of UK inflation, albeit it now starts from a lower base. We expect inflation to remain below 2% over the first quarter of this year and only start rising gradually back towards 2% as a strong recovery and fast-falling unemployment add to price pressures. With the BoE having moved away from forward guidance towards more data-driven monetary policy, low inflation will help it keep rates on hold until the second quarter of 2015.

Equities | Storm over for now

Calm has returned to equity markets. The volatility of late January has subsided and shares have recovered much of their losses. The relative tranquillity can be seen in the VIX index of volatility in the US stock market, which has dropped from 24% on 2 February to just under 14% – near the average over 2013.

While equity valuations remain somewhat challenging in the US, we continue to find more attractive opportunities in other markets, most notably Europe. Corporate confidence in the eurozone declined slightly in February but continues to indicate expansion. This is consistent with recent growth figures and lending surveys, which all point to continuing economic recovery. Very low inflation remains a concern although we expect the European Central Bank (ECB) to act by providing more liquidity. Even if the ECB doesn’t cut rates at its next meeting, European equities remain well supported by the continued recovery, underpinning our overweight stance.

Bonds | Little risk of near-term inflation

Inflation has fallen over the last year in Europe and the US, with ‘breakeven rates’, a market-based measure of inflation expectations, following a similar downward trajectory. Low inflation has been a persistent problem in the euro area and with the ECB appearing complacent, the risk of deflation is mounting. UK inflation has also fallen below the Bank of England’s 2% target for the first time since November 2009, although faster-than-expected rises in producer output prices could be early signs of building price pressures driven by the strong recovery in the UK economy.

Overall, we don’t believe that inflation in developed markets will rise significantly over the medium term given the economic slack that remains in the global economy and with lending still not having recovered to pre-crisis levels. As a result we maintain a neutral view on inflation-linked bonds relative to nominal government debt. While we see little need for short-term inflation protection, low breakeven rates provide an opportunity to buy cheap insurance against possible future inflation.

Currencies | Growth bolsters Singapore dollar

Singapore’s growth outlook is improving on the back of manufacturing and exports. Increasing global trade bodes well for a small, open economy like Singapore. Given the mix of relatively higher growth and a rise in inflation, we expect the Monetary Authority of Singapore to continue a gradual appreciation of the Singapore dollar (SGD). Though trimming of US stimulus could fuel outflows from Asian economies such as Singapore, weighing on the currency, we forecast SGD strengthening to 1.23 per US dollar by year-end, from around 1.2650 currently.

 

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