Markets reacted sharply after the surprise results of the U.K. general election last week. Prime Minister David Cameron’s conservative party won a majority in Parliament, a shocking defeat to Labor that was not at all predicted by the pre-election polls. As a result, the British pound sterling has risen nearly 4%, UK 10-year government bond yields are up by 15 basis points, and equities dropped slightly lower.
The primary takeaway is that the electorate seems happy with the current administration, which, by the way, carried out a policy of austerity to try to rein in its fiscal imbalances. In addition though, PM Cameron has promised to proceed with a referendum about whether or not to leave the European Union. There may also be another referendum on Scottish independence. These are pretty long term events however – probably 2017 and beyond.
What are the more immediate prospects for the U.K. in the post-election landscape? For U.S.-based observers, it looks pretty familiar. Unemployment data released this week is 5.5% in the U.K., compared to 5.4% in the U.S. Bloomberg estimates of real GDP for the U.K. are at 2.80%, compared to 2.60% in the U.S. U.K. 10-year government bond yields are around 2.00%, with the U.S. just 20-30 basis points higher. The Bank of England’s base rate is 0.50%, compared to 0.25% with the U.S. Fed.
The Bank of England released its quarterly inflation report this week, which touches on a lot of economic factors that the BoE is watching. Overall, the bank is not worried about inflation and believes that the economy will grow moderately. For policy purposes, market expectations are expecting the next move to be up by 25 bp, with the timing split between fall of this year and early 2016, arguably a few months after the U.S. Fed makes its first move. So again, they look a lot like us right now.
My View: It makes sense for the U.S and U.K to be somewhat in sync. There is still some variability as markets overshoot and undershoot. As to the level of sterling, we think the recent U.S. weakness against other currencies, including pound sterling, is a correction and do not look for the British pound to gain much more on the year.
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