Trade Floor Update: UK and Eurozone Outlook

Mike Amey discusses PIMCO’s growth and inflation forecasts for the UK and eurozone, and what they could mean for policy makers and investors over the course of 2018.

In this month’s Trade Floor Update we sat down with Mike Amey, Head of Sterling Portfolio Management and ESG Strategies, to discuss market moves, our outlook for 2018 for the UK and eurozone, and the potential implications for investors. Watch the full video or read the transcript below, edited for length and clarity.

Q: How did markets end 2017?

A: Markets generally ended 2017 pretty well, led by the U.S. stock market which closed at new highs. And the catalyst of that, of course, was the U.S. tax reform agreed at the end of last year. So risk assets generally did pretty well. In the bond market, government bonds, U.S. treasuries in particular, closed the year at a high of about two and a half percent. Other bond markets across Europe were more stable. As you would expect with risk assets doing well, corporate bonds ended the year very well and so we had quite a strong, in general, end to the year.

Q: What are our growth expectations for the UK and eurozone?

A: In the UK, we expect growth to be fairly stable at about one and a half percent, which is roughly speaking where it ended 2017. Inflation, we think, is probably peaking at the end of 2017, beginning of 2018, at about three percent, and will be trending back down towards target as we get to the end of 2018.

In the eurozone, we expect growth to hold at around two to two and a half percent, led by very low interest rates. Here the challenge remains inflation, which we think will remain below target, and probably creep up into the low one percents.

Q: How will policy makers respond?

A: On the one hand, you have the Bank of England (BOE) who started to raise rates in 2017. If we do get some kind of deal on Brexit, which is one of the risk factors for the UK, we think it's likely that the BOE will continue to raise rates. Our expectation is one or two hikes in 2018.

If we look at the eurozone, we know a lot of the story already for the first part of 2018, which is the European Central Bank (ECB) halving its monthly bond buying from €60 to €30 billion. Our expectation, if our growth numbers are correct, is that quantitative easing will end in September, 2018 and, as we move through the year, it’s likely that the ECB will start to talk about potential interest rate rises.

Q: What are the risks to these forecasts?

A: If we think about the risks around these scenarios, the biggest risk to the UK is the Brexit negotiations. Our central expectation is that some form of transitional deal will be done and so it will be a relatively smooth period. A quicker deal would be good for business confidence and potentially growth. Conversely, if the talks break down, then we could end up in a much more difficult situation with growth coming under pressure as a result of a weaker sterling.

Regarding the eurozone, the issue is whether you can maintain this very strong economic momentum. It’s possible: a lot of the early signs are that growth may be accelerating slightly in some economies. So your upside is clearly there. On the downside, the euro has been very strong and that could put pressure on growth as we move through the year.

Q: What are the investment implications for European investors?

A: In the UK, markets are priced for two interest rate rises by the middle of 2020. We think we may get one to two over 2018 so we are cautious on UK interest rates.

In Europe, things are a little bit more nuanced because the ECB is still physically buying bonds for most of this year. Therefore, we think it’s potentially a yield curve story. Some of the downwards pressure from QE should ease on long bonds as we go through the year so we’re moderately cautious on European duration.

For risk assets, corporate bond spreads are at multiyear lows so we think corporate credit is fair to moderately fully priced. As a result, we’re trying to find areas where there is still a liquidity or complexity premium in the market, which tends to lead us towards the more securitized type of markets where we still think there is that complexity premium. So, in general, we still think there are some spread assets out there to buy, but we're certainly more cautious on some of the classic markets of the corporate sector.

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Mike Amey

Head of Sterling Portfolio Management and ESG Strategies

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