People walk past the Bank of England building in London on May 8.Carlos Jasso/Reuters
Traders upped bets for a Bank of England rate cut in August, helping to underpin a pre-election rally for British stocks and government bonds even though the central bank left rates on hold at a 16-year high on Thursday.
After the BoE delivered its widely expected decision it hinted that it was edging closer to cuts, prompting money markets to place a 44 per cent probability on a move in August, up from around 32 per cent a day earlier. They priced in a 90 per cent chance of a September cut.
Wednesday’s data showing British inflation has dropped to the BoE’s 2 per cent target have encouraged those bets.
Investors now widely see rate cuts boosting the British economy alongside a predicted landslide in the July 4 general election for the opposition Labour Party, which claims it can rebuild growth and run the country’s debt-laden finances cautiously.
That’s a turnaround for British markets scarred by the 2016 Brexit vote and former Conservative prime minister Liz Truss’s under-funded 2022 mini-Budget.
“Rate cuts are definitely coming and we have a stable outlook for government for the next few years,” Morningstar European strategist Michael Field said.
James Briggs, a portfolio manager at Janus Henderson, said he had a “relatively upbeat” stance toward British stocks, corporate credit and government bonds, known as gilts.
He said British equity and credit valuations did not yet reflect the economy’s improving prospects and that gilts would benefit because “that tail risk of unorthodox fiscal policy is off the table.”
London’s FTSE 100 share index was steady just below record highs hit in May on Thursday. Sterling slipped 0.2 per cent to around 84.58 per cent per euro, but held near its strongest levels since 2022.
Two-year gilt yields dropped to their lowest since March after the BoE’s decision, LSEG data showed.
British bonds, which have outperformed U.S. and euro zone government bonds this month, rallied as the BoE said that the outlook for rate cuts was “finely balanced.”
Pictet Asset Management senior economist Nikolay Markov was negative on gilts because he suspected Labour, which has a long held image as a tax-and-spend party, might prioritize public spending over keeping state borrowing under control.
“The public finances are not in good shape,” Mr. Markov said, adding that potential moves by Labour to stimulate the economy would be inflationary.
Economists polled by Reuters expect the British economy to grow by 0.7 per cent this year, in an upgrade to earlier forecasts that had placed Britain at the bottom of the league table for predicted growth among advanced economies in 2024.
Becky Qin, multi-asset portfolio manager at Fidelity International, said she would keep a neutral stance on British stocks until she saw further signs of sustainable economic growth.
“Inflation data is also not as good as the BoE probably hoped for,” she said, referencing British services sector inflation that stayed stubbornly high at 5.7 per cent in May.
While British markets are rallying, there are few signs as yet that they are picking up long-term support.
Tracker funds that offer low-cost exposure to British equity indices have pulled in new money during three of the last four weeks since Prime Minister Rishi Sunak called the election, data from Lipper Global shows.
Actively managed British stock funds, which are a longer term commitment because they charge higher fees and promise superior returns over time, have suffered outflows in recent weeks in a trend that has persisted for years.
Janus’s Mr. Briggs said a recent spate of takeovers of British-listed companies could prompt investors to question if they were missing out on bargain valuations.
Over all, the mood among investors toward Britain was buoyant as rate cut hopes added to the pre-election buzz.
Yvan Mamalet, senior market strategist at SG Kleinwort Hambros, said his firm was bullish on British stocks and gilts, although he expected rate cuts to pressure sterling.
And Newton Investment Management fixed income portfolio manager Carl Shepherd said he favored long-term gilts.
“There are idiosyncratic risks in the UK and there is that sticky services inflation, but I think [once we] get the election out of the way, there’d be hopefully a period of more stability.”
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