Rise in gilt yields and sterling won’t last

Even though we expect the Bank of England to raise interest rates further from 3.50% now to a peak of 4.50%, we doubt the recent increase in gilt yields will be sustained. Instead, we think yields may fall from 3.60% currently to 2.75% by the end of 2023 as a weaker economy and falling inflation pushes the Bank to cut interest rates further and faster than investors expect in 2024. We suspect the recent rally in sterling is set to go into reverse as the global recession will cause the US dollar to strengthen and the pound to weaken. While lower bond yields and a weaker pound may provide some support for UK equity prices, that will probably not be enough to offset the effect of a decline in investors’ appetite for risk in the near term. We forecast the FTSE 100 to fall from around 7,400 currently to a low of around 6,800 by the middle of 2023, before rebounding as the markets see the end of the global recession approaching.