World Economy

UK Buffeted by Conflicting Forces

UK Buffeted by Conflicting ForcesUK Buffeted by Conflicting Forces

The UK is currently being buffeted by conflicting forces. Inching towards its first interest rate rise amid dramatic shifts in the value of the pound, the UK is also shrouded by one of the most uncertain general election outcomes in living memory.

This is a recipe for market volatility in the short term. But for most investors the pace of growth in Europe and the timing of the first US rate rise are going to be much more important, Money Observer reported.

Investors entered 2015 feeling confident about the US economy and hesitant about the prospects for Europe. The mood has shifted since then, as news flow from the eurozone started to turn positive and US corporates felt the pinch of the rising dollar. But the strength of the US recovery and the timing of the first US rate rise are still top of the agenda for most global investors.

‘Our best guess is that the US central bank will raise its key policy rate in the second half of 2015. But its decision has been complicated by plummeting inflation, a rising currency and a slight pullback in US economic growth. The Federal Reserve would like to start the US on the road to higher rates but senior officials continue to believe the risks of tightening too soon are greater than the risks of tightening too late,’ said David Stubbs, Global Market Strategist for JPMorgan Asset Management.

  UK Stuck in the Middle

Not so long ago, many thought the Bank of England might raise interest rates before the US. Now this seems deeply unlikely. Political uncertainty looms large over the upcoming general election and a plummeting inflation rate has pushed market expectations for the first UK rate rise further into the future.

But with the UK economy still showing signs of healthy momentum and wage growth picking up investors would be misguided to assume that a 2015 rate rise has been entirely ruled out.

“Political uncertainty will dominate news headlines and likely cause market volatility in the months ahead but, for long-term investors, the foremost risks for the UK relate to its long run productivity growth and its continued membership of the European Union. Neither of these will be decided in the upcoming election,” said Stephanie Flanders, Chief Market Strategist for Europe at JPMorgan Asset Management.

“The largest short-term concern for investors and the UK economy is arguably the pound, which has fallen sharply against the dollar but is reaching multi-year highs against the euro. It is an uncomfortable combination for many major UK companies, though the fundamentals for the domestic recovery look stronger than many on the Continent,” said Stubbs.

  Europe’s Recovery Story?

Europe’s economy has surprised on the upside in recent months, with a surge in activity in Germany as well as signs of improvement in France and Italy. The European Central Bank (ECB) waited too long to start a full-scale program of sovereign bond purchases, but if there was a good time to come late to the quantitative easing (QE) party, the ECB seems to have chosen it.

Investors who bought into the eurozone recovery story have been handsomely rewarded, at least in euros. Every major eurozone stock index recorded double digit growth (CHK) in local currency terms in the first three months of 2015.

However, this outperformance shrinks dramatically if you translate returns into dollars or pounds. Both the fall in the euro and the emergence of negative yields in many eurozone bond markets are a reminder that Europe is still a long way from normal.