Market Analysis

Traders increased their expectations of a Bank of England rate cut in August, supporting a rally in UK stocks and government bonds ahead of an upcoming election, despite the central bank keeping rates unchanged at a 16-year high on Thursday.

Following the BoE's widely anticipated decision, markets reacted with a higher probability—now at 44% for an August cut, up from about 32% the previous day—and a 90% likelihood of a September cut, buoyed by recent data showing UK inflation hitting the BoE's 2% target.

Investors now anticipate rate cuts to stimulate the UK economy alongside predictions of a strong electoral performance by the opposition Labour Party in the July 4 general election, which pledges careful management of the country's debt-heavy finances to foster growth.

This marks a turnaround for UK markets previously impacted by Brexit uncertainties and fiscal challenges under former Conservative Prime Minister Liz Truss's 2022 budget.

"Rate cuts are imminent, and we foresee a period of political stability in the coming years," noted Morningstar European strategist Michael Field.

James Briggs, portfolio manager at Janus Henderson, expressed optimism towards UK stocks, corporate credit, and government bonds (gilts), noting that current valuations do not fully reflect the improving economic outlook and that gilts stand to benefit from reduced fiscal policy risks.

London's FTSE 100 index hovered just below its May record highs on Thursday, while the pound dipped slightly against the euro to approximately 84.58 cents, maintaining levels not seen since 2022.

Two-year gilt yields fell to their lowest since March following the BoE's decision, according to LSEG data. UK bonds have outperformed US and euro zone counterparts this month, rallying as the BoE signaled a finely balanced outlook for rate cuts.

However, some analysts remain cautious about gilts, citing concerns that Labour's historically pro-spending stance could lead to inflationary pressures if public spending priorities outweigh fiscal discipline.

Economists surveyed by Reuters have upgraded their UK growth forecast for 2024 to 0.7%, reflecting a more positive outlook compared to earlier predictions placing Britain at the bottom for growth among advanced economies.

Becky Qin, multi-asset portfolio manager at Fidelity International, maintains a neutral stance on UK stocks pending clearer signs of sustained economic growth, particularly noting stubbornly high inflation in the services sector at 5.7% in May.

While UK markets show signs of short-term optimism, the long-term outlook remains uncertain. Tracker funds attracting new investments since Prime Minister Rishi Sunak's election announcement contrast with outflows from actively managed UK stock funds, suggesting ongoing investor caution.

Yvan Mamalet, senior market strategist at SG Kleinwort Hambros, expressed bullish sentiment towards UK stocks and gilts despite expectations that rate cuts could pressure the pound.

Newton Investment Management's Carl Shepherd favored long-term gilts despite acknowledging risks such as persistent services sector inflation, anticipating greater stability post-election.

Paraphrasing text from "Reuters" all rights reserved by the original author.