Optimism is brewing among investors as they take a more positive view on UK assets, such as the pound and stocks. Despite recent challenges including floods, storms, and strikes, the economic outlook is brightening, prompting Goldman Sachs Group Inc. and Bloomberg Economics to raise their growth projections for the UK. Analysts are increasing their forecasts for the sterling, and investors are becoming bullish on the currency for the first time in three months. There are also signs of a potential turnaround in the stock market, driven by stronger performance from retailers.
While these bets on the UK outperforming carry some risks, such as ongoing disruptions to transportation and health services due to weather and strikes, and the possibility of inflation remaining elevated, overall confidence is growing. The pound has maintained its momentum in 2024, even as the US dollar rebounded against other major currencies. Goldman Sachs has revised its pound forecast, predicting a gain to $1.30 in six months, and Fidelity International is even more optimistic, expecting it to strengthen to $1.40 this year.
Evidence of a stronger-than-expected economy is accumulating, with UK house prices defying predictions of a slump and mortgage approvals surpassing forecasts. Additionally, final services and composite PMI readings for December were revised significantly upward. Rising wages in real terms and anticipation of looser monetary policy from the Bank of England (BOE), with expectations of five quarter-point rate cuts this year, further support the outlook for consumers and the broader economy. This provides Chancellor of the Exchequer Jeremy Hunt with more flexibility to implement tax cuts leading up to the upcoming election.
Positive signals are also emerging in the stock market, with Next Plc, often seen as a high-street bellwether, raising its profit forecast after a successful Christmas period. However, HSBC analysts remain cautious, warning of a potential decline in spending during the first quarter as consumers "pay back" what they spent over the holiday season. Citigroup strategists add that higher rates could lead to increased unemployment, while a weaker US dollar and oil prices may weigh on London-listed stocks.
Despite the more encouraging economic expansion, it remains fragile. The growth outlook is likely to be constrained by high borrowing costs and ongoing tightening of fiscal policy. Many households are still recovering from the impact of inflation, and monthly GDP figures for November could indicate a technical recession in the second half of 2023 if the economy continues to contract. Furthermore, planned industrial strikes in early 2024 will likely create short-term disruptions.
The strike by the RMT union causing a near halt to the London Underground and ongoing disagreements over pay with junior doctors indicate a tight labor market, but not necessarily a sign of economic strength. Wages continue to grow at 7% despite weak economic conditions, adding to inflationary pressures. This dampens the outlook for bonds, with a less buoyant forecast and a potential delay in any recovery following the bond market turmoil of 2023.
Citigroup and Natwest project benchmark UK yields to surpass 4% again this year. Investors, including Federated Hermes Limited and RBC BlueBay Asset Management, have turned bearish on gilts. Bond yields had risen from 1% to as high as 4.75% in August 2023 before undergoing a downward trend to around 3.5% by the end of the year.
The future outlook for the UK is now less certain, leading some investors to reduce their exposure to gilts after the rally and the repricing of BOE expectations. Despite the challenges and uncertainties ahead, the overall sentiment towards UK assets remains positive, driven by a more promising economic performance and potential policy easing from the BOE.