UK Cabinet reshuffle deals our forecasts a stronger hand - Capital Economics
Capital Daily

UK Cabinet reshuffle deals our forecasts a stronger hand

Capital Daily
Written by Hubert De Barochez

The surprise change of Chancellor as part of today’s UK Cabinet reshuffle bolsters our view that looser fiscal policy and tighter monetary policy are on the way. In turn, this supports our forecasts for a stronger pound, higher Gilt yields, and an outperforming UK stock market over the next couple of years.

  • We think that Germany’s GDP contracted in Q4 (07.00 GMT)
  • US retail sales probably rose in January thanks to unusually-warm weather (13.30 GMT)
  • We expect policymakers in Mexico and Peru to cut interest rates

Key Market Themes

The surprise change of Chancellor as part of today’s UK Cabinet reshuffle bolsters our view that looser fiscal policy and tighter monetary policy are on the way. In turn, this supports our forecasts for a stronger pound, higher Gilt yields, and an outperforming UK stock market over the next couple of years.

To re-cap, Sajid Javid resigned from his position of Chancellor today, perhaps owing to his reluctance to increase public borrowing significantly. He was quickly replaced by Rishi Sunak, whose previous votes in Parliament suggest that his views are much more aligned with those of Prime Minister Boris Johnson. All told, this Cabinet reshuffle could well allow the government to push through even bigger increases in public investment. And tax cuts could also be on the cards.

As a result, it is becoming more likely that the quarterly rate of GDP growth will rebound this year, which would remove the need for looser monetary policy. In fact, investors have revised their expectations for interest rates in the UK up fractionally today – which in turn has led the 10-year Gilt yield to rise by a few basis points, to 0.65%. However, they are still a long way from our view that the Bank of England will remain on hold this year and raise Bank Rate by 25bp next year. (See Chart 1.)

Chart 1: Bank Rate (%)

Sources: Bloomberg, Capital Economics

With all that in mind, we are comfortable with our expectation that the 10-year Gilt yield will continue to rise over the next couple of years. We forecast that it will reach 1.00% by the end of 2020, and 1.25% by the end of 2021.

Our hawkish view about monetary policy in the UK – at least compared to what is priced in to the markets – also helps to explain why we think that sterling will make more gains in the coming two years. (Another reason is that we expect the UK and the EU to agree eventually on some sort of a fudge that avoids a big step change in their trading relationship.) The pound has jumped above $1.30 after Mr Javid’s resignation, and we forecast that it will end 2020 at $1.35 and 2021 at $1.40.

Meanwhile, although UK large-cap equities have failed to make gains following the announcement – presumably because they have been weighed down by a stronger pound – we doubt that this will remain the case for long. We think that stronger economic growth, reduced Brexit uncertainty, and the possibility of corporate tax cuts will make the MSCI UK equity index the best performer among similar indices for the ten largest developed economies’ stock markets. (See Chart 2.) (Hubert de Barochez)

Chart 2: Changes In MSCI Local-Currency Equity Indices From Current Levels To Our End-2021 Forecasts (%)

Sources: Bloomberg, Capital Economics

Selected Data & Events




CE Forecasts*

Fri 14th


GDP (Q4, Prov., q/q(y/y))






Industrial Production (Jan)





*m/m(y/y) unless otherwise stated; p = provisional

Key Data & Events


The rise in headline CPI inflation to a 15-month high of 2.5% in January was entirely due to base effects. The continued stability of core inflation reinforces our view that the Fed is unlikely to raise interest rates again for the foreseeable future.

We expect data on Friday to show that retail sales rose at a solid pace in January, potentially boosted by the unusually-mild winter weather. Along with another strong reading from the University of Michigan’s consumer confidence gauge in February, that would point to a rebound in real consumption growth in the first quarter. Otherwise, we expect industrial production to have fallen again in January, but only because of a weather-related plunge in utilities demand. The improvement in the surveys suggests that manufacturing output is starting to recover, even if the coronavirus shutdown in China may cause some knock-on disruption to US firms over the next couple of months. (Andrew Hunter)


Q4 GDP data for the Netherlands showed that the economy expanded by 0.4% q/q, unchanged from Q3. Despite a decent end to the year, growth slowed overall in 2019 and we think that it will slow further this year.

A raft of Q4 GDP data will be published on Friday. We forecast Germany’s economy to have contracted by 0.1% q/q, while economic growth in Portugal is likely to have picked up a touch, to 0.4%. We now think that Eurostat will revise down its estimate of Q4 GDP for the euro-zone as a whole to zero, from 0.1% in the first estimate.

In the Nordics, Q4 GDP is likely to have slowed in both Finland and Denmark.

In the UK, we already thought that the Budget on 11th March would announce a further loosening in fiscal policy worth 0.5% of GDP, which together with the extra government spending announced in September 2019, would add up to a fiscal boost of 1.0%. The unexpected resignation of Sajid Javid as Chancellor today and the promotion of Rishi Sunak to the role could mean that the Budget will include even more stimulus, which would increase the upside to our already above-consensus forecasts for GDP growth, interest rates, gilt yields and the pound. (See Key Market Themes.) (Melanie Debono & Ruth Gregory)


The daily number of new coronavirus cases reported rose sharply as the authorities widened the definition of what it counts as a virus case. But the jump in new cases is somewhat misleading: it is the result of all clinically-diagnosed cases since the start of the outbreak being added to the figures in a single day. Accounting for the change in definition, the number of new cases has continued to trend down. As such, we expect efforts to get businesses back up and running in the coming days will continue.

We continue to track the latest developments on our coronavirus page, which includes charts with daily data on energy usage, passenger traffic and congestion levels. There are still few signs of a recovery in economic activity in the latest figures, even after the extended Lunar New Year holiday ended. (Martin Rasmussen)

Other Emerging Markets

In the Middle East and North Africa, the IMF confirmed that it will provide technical assistance to crisis-stricken Lebanon, which is likely to be the first step towards a fully-fledged bailout. In our view, any IMF programme will be conditional on a large devaluation of the official exchange rate – perhaps as much as 50% against the dollar – and a significant write-down of Lebanon’s sovereign debt. (See here.)

In Latin America, we think that Mexico’s policymakers will cut their overnight rate from 7.25% to 7.00% at their meeting on Thursday, in line with market expectations. But we hold a non-consensus view that the easing cycle will soon end and anticipate only one further cut, in April. An interest rate decision is also due in Peru. We expect the central bank there to cut the policy rate by 25bp as well. But this will probably mark the end of its easing cycle. Elsewhere, national accounts figures are likely to show that Colombia’s GDP growth ticked down from 3.3% y/y in Q3 to 3.1% in Q4. Our forecast is for growth to slow further to 2.8% this year.

In Sub-Saharan Africa, we think that the jump in mining output in South Africa in December (up 1.8% y/y, after a 1.0% y/y fall in November) paints a misleadingly-positive picture. Over Q4 as a whole, the economy probably contracted, tipping the country into another technical recession. (Edward Glossop)

Published at 16.10 GMT 13th February 2020.

Editor: John Higgins (+44 20 7811 3912)

Enquiries: William Ellis (+44 20 7808 4068)