UK financial markets have responded strongly to the deterioration in the outlook for the domestic and global economies over recent months, with equity prices and bond yields both falling sharply. However, for now at least, the markets appear to be pricing in only a relatively mild recession. If we are right in expecting the UK economy to contract by around 1.5% in 2009 and further in 2010, while official interest rates fall all the way to 1% or even below, then equity prices, bond yields and the sterling exchange rate may all have further to fall.
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