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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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Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
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Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

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