Market View July 2017 – what next for the markets?

Andrew Milligan

In this month’s market review I reflect on the Queen’s speech, what the Monetary Policy Committee’s (MPC) latest announcements mean for markets and recent developments in the UK residential property market. I also take a closer look at the US and European economies, and consider what lies ahead for global markets.

The Queen’s speech

I have been asked, following the Queen’s address to Parliament setting out the Government’s agenda for the coming year, which parts investors should pay particular attention to. However, on this occasion the Queen’s Speech only included few new proposals.

Instead, it is now time for the Government to prepare for the major legislative challenge of pushing through eight complex bills related to the UK’s planned departure from the European Union (EU). The amount of detail and the intricacy involved in unravelling decades of EU legislation should not be under-estimated, especially for a minority government.

Interest rates split opinion

The Bank of England is most split on interest rates since 2011 with three out of its eight MPC members voting for an immediate rise to keep inflation in check.

These announcements certainly surprised markets as investors had thought other central banks would lead the way in terms of moving interest rates. Nevertheless, against the backdrop of higher inflation it’s understandable that some members of the MPC might want to withdraw the emergency support for the economy which was implemented after the Brexit vote last year.

Currently the UK government bond (gilts) market is pricing in a 50-50 likelihood that the Bank of England will raise interest rates this November, so the next few speeches from MPC members will be examined with great interest. As ever, the Bank of England’s response will be dependent on data such as economic growth figures, inflation and employment rates. It is giving warnings, it has not yet made up its mind.

Markets have already priced in some but not all of a move on rates. So if the Bank of England did act we’d expect some further movement in sterling against other currencies, for example.

A drop in the UK residential property market

It’s no surprise that there’s been a drop back in the UK residential property market as we’re seeing the housing market come under pressure from several sources.

First of all housing is generally expensive while wages grow slowly. Secondly, the Bank of England is giving due warning to the banking system that even if it doesn’t raise interest rates then it will have to take other action to tighten up the supply of credit – this is called macro-prudential regulation. And thirdly, all political parties are keen on building a significant number of new homes, for either rent or sale – and more supply usually means lower prices.

A more positive outlook for Europe

There’s been a clear movement of investment out of the US and into Europe. Although the US economy continues to grow quite well, investor optimism about a sizeable tax cutting package has receded in recent months. This reflects the difficulty the Trump administration currently has in pushing major legislation through Congress.

On the other hand, the European economy is recovering steadily, with lower unemployment supporting consumer spending and many companies benefiting from the upturn in global trade. The election of President Macron in France has also reassured overseas investors about the political situation across Europe. At Standard Life Investments, we have been positive about Europe for some time – but while we remain invested there, we’re looking carefully to assess when all the good news has been priced in. The real question is, after investment has moved from the US to Europe, where will it move next?

US growth – can it increase?

The Federal Reserve (the Fed) raised the target range for its overnight interbank lending rate (known as the federal funds rate) from 1% to 1.25% at its June 2017 meeting. But it’s clear the Fed is trying to be very transparent in the marketplace in terms of announcing and then following through with interest rate or balance sheet moves. It doesn’t want to be the cause of greater market volatility.

Our forecasts are that the US economy does not grow more quickly into 2018 than it is currently. However, as unemployment steadily comes down the Fed does expect that wages will rise. This will lead it to take action sooner rather than later to limit future inflation and make sure the economic recovery is long lasting.

If you have any questions about your investments, as always we recommend you speak with your financial adviser.

The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your investment can go up or down, and may be worth less than you paid in. Information is based on our understanding in July 2017.