Global Economy & Markets, Weekly Roundup 01/11/22
UK political risk premium has eased, supporting financial assets, albeit macroeconomic headwinds for the UK remain
Key Takeaways
The easing of political uncertainty in the United Kingdom has led to a stabilization of the British Pound. The trade-weighted Sterling Effective Exchange Rate Index has appreciated by +6.2% compared with its trough on September 28th, albeit remaining -5.5% below January 2022 levels. In addition, Gilt yields have declined across the board by 50-60 bps.
The significant weakening of GBP overall in 2022 has contributed to a substantial divergence in equity performance between UK companies with high global revenue exposure, which can benefit from a weaker GBP, and those with a relatively elevated domestic exposure. Indeed, FTSE100 has overperformed its domestic-oriented peers by circa 20% year-to-date.
In terms of valuations, the 12-month forward P/E ratio of the FTSE100, where an elevated 80% of the revenues of its constituents’ stem from abroad, stands at 8.9x versus a 20-year average of 13.0x and for the FTSE 250 at 10.4x versus a 20-year average of 13.8x. Thus, despite the significant overperformance year-to-date, the current relative valuation discount (-14%) remains wide compared with the long-term average discount (-6%).
Regarding economic activity, real GDP is estimated to have declined by -0.3% qoq (+2.2% yoy) in Q3:2022, following a +0.2% qoq increase (+4.4% yoy) in Q2:2022. The outlook could be influenced, inter alia, by the final fiscal decisions, with Chancellor’s Autumn Statement due on November 17th. According to the IMF, UK real GDP will barely grow overall in 2023 (+0.3%), from +3.6% in 2022.
CPI inflation in the UK stood at 10.1% yoy in September, the highest since 1982. At the same time, the pass-through of higher manufacturing costs to consumer prices appears to be still incomplete, advocating in favor of residual pipeline pressures, at least for prices of goods (+13.2% yoy in September). The outlook is uncertain given, inter alia, pending clarifications regarding government policies for State subsidies of energy bills. In any case, the recent stabilization of GBP has alleviated fears of additional price pressures from imported inflation.
Investors’ expectations regarding the cumulative size of monetary policy tightening going forward have declined (see graph below). The Bank of England is expected to proceed with a 75 basis points hike to the Bank Rate on November 2nd, to 3.0%. Moreover, the BoE announced Quantitative Tightening (QT) details, following the termination of the emergency gilt purchases, activated in order to combat political-induced market turbulence, from September 28th to October 14th (£19 bn cumulatively).
Specifically, in the remainder of Q4:2022, the reduction of gilts in the Asset Purchase Facility (holdings of £838 bn or 37% of 2021 GDP), will proceed via sales. Eight auctions of £0.75 bn each (£6 bn in total), evenly distributed across the short (3-7 years) and medium (7-20 years) term maturity spectrum will take place, with the first one on November 1st. Later on, the schedule will be set on a quarterly basis (for Q1:23, announcement is planned for December 16th, 2022). The goal for a reduction in the APF stock of gilts of “around £80 bn” by September 2023 compared with September 2022, remains. Given the profile of maturing gilts, the proceedings of which will not be reinvested, total sales of c. £39 bn are implied over that period.
Key Takeaways
The easing of political uncertainty in the United Kingdom has led to a stabilization of the British Pound. The trade-weighted Sterling Effective Exchange Rate Index has appreciated by +6.2% compared with its trough on September 28th, albeit remaining -5.5% below January 2022 levels. In addition, Gilt yields have declined across the board by 50-60 bps.
The significant weakening of GBP overall in 2022 has contributed to a substantial divergence in equity performance between UK companies with high global revenue exposure, which can benefit from a weaker GBP, and those with a relatively elevated domestic exposure. Indeed, FTSE100 has overperformed its domestic-oriented peers by circa 20% year-to-date.
In terms of valuations, the 12-month forward P/E ratio of the FTSE100, where an elevated 80% of the revenues of its constituents’ stem from abroad, stands at 8.9x versus a 20-year average of 13.0x and for the FTSE 250 at 10.4x versus a 20-year average of 13.8x. Thus, despite the significant overperformance year-to-date, the current relative valuation discount (-14%) remains wide compared with the long-term average discount (-6%).
Regarding economic activity, real GDP is estimated to have declined by -0.3% qoq (+2.2% yoy) in Q3:2022, following a +0.2% qoq increase (+4.4% yoy) in Q2:2022. The outlook could be influenced, inter alia, by the final fiscal decisions, with Chancellor’s Autumn Statement due on November 17th. According to the IMF, UK real GDP will barely grow overall in 2023 (+0.3%), from +3.6% in 2022.
CPI inflation in the UK stood at 10.1% yoy in September, the highest since 1982. At the same time, the pass-through of higher manufacturing costs to consumer prices appears to be still incomplete, advocating in favor of residual pipeline pressures, at least for prices of goods (+13.2% yoy in September). The outlook is uncertain given, inter alia, pending clarifications regarding government policies for State subsidies of energy bills. In any case, the recent stabilization of GBP has alleviated fears of additional price pressures from imported inflation.
Investors’ expectations regarding the cumulative size of monetary policy tightening going forward have declined (see graph below). The Bank of England is expected to proceed with a 75 basis points hike to the Bank Rate on November 2nd, to 3.0%. Moreover, the BoE announced Quantitative Tightening (QT) details, following the termination of the emergency gilt purchases, activated in order to combat political-induced market turbulence, from September 28th to October 14th (£19 bn cumulatively).
Specifically, in the remainder of Q4:2022, the reduction of gilts in the Asset Purchase Facility (holdings of £838 bn or 37% of 2021 GDP), will proceed via sales. Eight auctions of £0.75 bn each (£6 bn in total), evenly distributed across the short (3-7 years) and medium (7-20 years) term maturity spectrum will take place, with the first one on November 1st. Later on, the schedule will be set on a quarterly basis (for Q1:23, announcement is planned for December 16th, 2022). The goal for a reduction in the APF stock of gilts of “around £80 bn” by September 2023 compared with September 2022, remains. Given the profile of maturing gilts, the proceedings of which will not be reinvested, total sales of c. £39 bn are implied over that period.