Equity market turmoil
Equity markets had a tumultuous start to 2018. Following a long bull run last year, which even accelerated towards the end of the year and into early 2018, sentiment shifted - temporarily at least. In our view, the volatility seen in late January and at the start of February is mostly a reflection of the equity market preparing for rising rates - particularly in the US. We do not see the recent turmoil as a sign of the equity market readying for lower economic growth. We should also note this was mainly an equity market and to some extent a bond market story, but not an FX market story. Exchange rates have remained relatively calm.
Oil price beats a retreat
The price of oil was high at the start of the year - around USD70 a barrel. However, the oil price has since retreated on the back of several factors. 1) General financial market sentiment - when equity prices fall, commodity prices tend to follow suit to some degree. 2) The slide in the USD has stopped. A weakening dollar last year help underpin oil prices, so the recent stabilisation in the greenback means that particular tailwind has stopped. 3) The number of oil rigs in the US has increased significantly in recent weeks, indicating that US shale oil producers are getting ready to ramp up production in the coming months. Higher production from this segment will put a damper on further price increases and we expect the oil price to hover close to current levels for the rest of the year. Global economic growth will be a supportive factor, but production is unlikely to have any problem keeping up with demand.
US wage growth picked up in January
The January US jobs report included surprisingly high hourly wage growth. Consumer price inflation was also higher than expected. However, a couple of surprises does not necessarily indicate a longer-term trend. Hence, we remain unconvinced that more sustained inflationary pressures are amassing in the US. That being said, these data surprises have, however, convinced the market that the Federal Reserve will hike interest rates four times by the end of 2019. A key uncertainty here is the effect of the more expansionary fiscal policy and tax cuts in the US, which on all parameters are historically accommodative - and in a situation where unemployment is low.
Bank of England ready to hike twice this year
Based on its 8 February MPC meeting, we now expect the Bank of England (BoE) to hike the Bank Rate to 0.75% as early as May (previously February 2019). As this seems like the beginning of a hiking cycle, we expect another BoE hike to follow in November, taking the Bank Rate to 1.00% by the end of 2018. Two additional hikes to 1.50% are likely in 2019.
Our expectations for UK monetary policy are more hawkish than consensus and market pricing, and we expect further increases in UK market rates in the coming 12 months - particularly at the short end of the yield curve (0-2 years). Given the outlook of higher yields in the UK, we have also revised our EUR/GBP forecast lower, as we now expect the BoE to tighten monetary policy considerably more than the ECB. Hence, we expect EUR/GBP to fall to 0.86 and 0.84 on a 6- and 12-month horizon, respectively, due to a combination of higher yields and further clarification on Brexit.
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