At the end of last year, I made the case that the elevated risk premium embedded in equity valuations could unwind to deliver a year of positive returns. The double-digit gains registered across European bourses and US Nasdaq indices are certainly indicative of an improvement in risk appetite even if the UK market has lagged.
My prediction was partly based on market participants being too pessimistic about the peak level of interest rates required to reduce aggregate demand given the scale of the monetary tightening already seen. I also felt that peak inflation could come down sharply this year. That has certainly been the case in Europe, and the UK will join the party next quarter when headline inflation receives the lagged benefit of the sharp decline in wholesale energy costs.
Falling UK inflation should act as an incentive for trade unions to settle their protracted pay talks, thus giving the UK economy, which has dodged recession despite suffering lost output during strikes, a boost. The fact that consumer spending has held up so well to date is informative, as is the stabilisation of the housing market. It suggests that as inflationary pressures ease, some of the benefit from falling energy costs – and this year’s downward shift in fixed mortgage rates – will find its way back into the economy and consumer spending, in particular.