Written by Ranjiv Mann, Senior Fixed Income Portfolio Manager at AllianzGI, ahead of the Bank of England meeting on 19th September 2024
UK economic growth has confounded the gloomiest expectations at the start of this year; growth has been edging higher, with the market expecting just over 1.0% real GDP growth this year.
Core UK CPI inflation (at 3.3% y/y) has also been stickier than in other developed markets. Following a 25bp rate cut in August, more recent comments from BOE Governor Bailey indicated that it was too early to declare victory on the fight against inflation, cautioning against a fast pace of rate cuts ahead. We therefore think that a majority of MPC members are likely to favour keeping rates unchanged at the September meeting.
Beyond the September meeting, however, we think that the UK labour market will continue to loosen, with wage growth and services inflation cooling further, supported by the disinflationary trend coming from energy prices. Meanwhile, the UK government is facing significant fiscal challenges and is set to maintain a tight fiscal stance at the upcoming Autumn Budget on 30th October.
The global economic growth backdrop is also beginning to flash some warning signals. Markets are beginning to pare back their lofty expectations for US growth, European and Chinese growth remains lacklustre and corporate fundamentals are starting to be challenged. Against this backdrop, commodity and energy prices are increasingly coming under downward pressure, pushing inflation expectations lower globally.
With economic data likely to continue supporting front-loaded rate cuts amongst other G10 central banks over the coming months, we expect the BOE to also signal its desire to ease policy further at subsequent meetings this year and into 2025.
Gilt market implications
We think markets have now sufficiently priced the improvement in the UK growth outlook, while inflationary pressures in the economy are also set to moderate. In addition, the UK fiscal stance is likely to become a drag for UK growth prospects. We believe that interest rate markets are insufficiently pricing BOE rate cuts over the next six to nine months in comparison to the European Central Bank and US Federal Reserve, and Gilt valuations increasingly look attractive versus other G4 markets.
In light of the above, we currently favour owning Gilts on a relative value, cross-market basis against German Bunds.
