In Q4, the UK economy expanded 0.5%, mainly due to government and consumer spending, while exports and investments both contracted. However, both employment and GDP growth is expected to slow in the first half of 2016 due to increased uncertainties before the referendum that might impede private consumption and investments. This is also seen in the business survey, with both service and manufacturing sector PMIs falling in February.
Meanwhile, UK’s CPI inflation and CPI core inflation are likely to remain subdued in 2016. CPI inflation had accelerated to 0.3% y/y in January from 0.2% y/y in December. The upcoming EU referendum in June represents a significant medium –to long-term risk factor for the UK economy.
“We see little evidence of Brexit risk premium priced in the Gilt market and, in our view, Brexit concerns are primarily a theme for the FX market”, says Danske Bank.
Admittedly, Standard & Poor’s have kept UK on a negative watch and a Brexit is expected to set off a downgrade of its sovereign rating. However, this might not essentially alter foreign investors’ appetite for Gilts drastically. Ahead of the EU referendum, the Bank of England’s hands more or less tied. UL money markets are likely to be fairly stable in the near term.
“We still expect the Bank of England to increase interest rates in Q1 17 but, with the great uncertainty surrounding the EU referendum, things could change rapidly after it”, says Danske Bank.
The market projects the central bank to hike rates in Q2 2019. However, the recent more dovish stance from the central banks globally is expected to be very supportive for global fixed income markets.
“We have lowered our 1-12M UK interest-rate swap forecasts some 15-25bp on the 5-10Y tenors, projecting lower rates at the long end of the curve, driven by lower global rates in the coming months. We expect a flat development in the 0-2Y segment in the coming one to three months”, says Danske Bank.
In the longer term, the UK interest rates are expected to be higher in the medium-term horizon, driven by BoE rate increases and higher US interest rates.
The material has been provided by InstaForex Company – www.instaforex.com