Expectations of a cut to the Bank of England’s (BoE) base rate before the end of the year reached an all-time high this week, following the Federal Reserves’s decision to reduce rates and as the chances of a no-deal Brexit increased and trade wars intensified.
Traders now see it as more likely than not that the Monetary Policy Committee (MPC) will cut interest rates at December’s meeting, an about-turn from anticipation of a rise that pervaded the market at the start of the year. In fact, expectations of a base rate cut from 0.75 per cent reached an all time-high this week at 55.6 per cent, based on futures and options pricing.
UK government debt has become increasingly popular with investors looking for safe-haven assets, pushing down 10-year yields below 0.5 per cent. Likewise, 10-year German bunds rallied, causing the yield to fall to an all-time low, while the 10-year US yield also fell to its lowest levels since October 2016.
In the UK, the rising chance of a no-deal Brexit has compounded broader concerns around the ongoing US-Sino trade war and the dovish stance adopted by the Fed and European Central Bank. In its most recent inflation report Threadneedle Street downgraded its growth forecasts for this year and next to just 1.3 per cent, but said that rates may have to rise to keep inflation at its target 2 per cent, but those forecasts were premised on an orderly Brexit.
The scenarios envisaged by the BoE in its August Inflation Report assume an orderly exit, but some investors now assume that if there was a no-deal Brexit “there would need to be some sort of emergency rate cut to deal with it”, said Brooks Macdonald deputy chief investment officer Edward Park.
But while central banks' ultra-loose monetary policies have fuelled a bull run in equity markets over the past decade, whether the prospect of further monetary easing drives a rerating in UK equities depends on how the market interprets the reasons for the BoE’s actions, said Aberdeen Standard Investments head of global strategy, Andrew Milligan.
“People have bought into the story that low rates are supportive of the business cycle,” he said. Where often markets start to worry is where the BoE is perceived to have cut rates because there is a recession ahead, he added.
That could include a weakening in the UK services sector – which has offset anaemic manufacturing output so far this year – or if data shows households are reducing spending on everyday items, he said.
Mr Park agreed that a rate cut would not necessarily benefit UK equities across the board. “Low rates are good for equities, but they are disproportionately good for growth stocks rather than for value stocks,” he said. That is partly because growth companies, which may be making little or no money at present, are boosted by lower financing costs to fund expansion. It is also part of the reason US equity indices – which contain a greater proportion of growth stocks such as tech companies – are trading at such a premium to the UK, he said.
A sustained rally in UK equities will also depend on attracting international investors, which may be deterred if there was a sizeable devaluation in sterling that made sterling-denominated dividends less attractive, he added.
