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Legg Mason Perspectives: Britain, the Bank, and Brexit

By Gordon S. Brown, PhD, Western Asset

With the Bank of England likely to keep rates very low and increase asset purchases, UK gilt yields and corporate bonds appear well supported; less so, the British pound.

June was already shaping up to be an interesting month for UK markets given the latest round of trade talks between the UK and EU, and the upcoming July 1 deadline to agree on an extension to the “transition period”. But with evidence emerging around the scale of the recession, and the resulting policy responses by the government and the Bank of England (BoE), there are additional factors that investors need to consider when assessing the implications for UK markets.


Growth contracted by 2% in Q1 compared to expectations of -2.6% and initial estimates from the BoE’s May inflation report of -3%. The BoE forecast UK GDP to contract by a further 25% in Q2 and to be -14% for 2020 as a whole—considerably more pessimistic than private-sector economists’ consensus forecast of around -8%. The BoE’s baseline is for growth to pick up “relatively rapidly” in H2 but for end-2019 activity levels not to be reached until late 2021. Inflation is expected to fall below 1%, reflecting both the slump in demand and recent developments in the price of oil, while unemployment is forecast to rise to around 8%. In response, the UK government has announced a significant increase in fiscal spending and related measures, including immediate spending of approximately 5% of GDP, deferrals equivalent to around 2% and other liquidity/guarantees equivalent to around 15%. Consequently, government borrowing is expected to increase to as much as 15% of GDP over the fiscal year 2020-21. Given the concurrent recession and large increase in fiscal spending, debt issuance for 2020-21 is estimated to increase to £250-300 billion, with the level of government debt/GDP expected to hit 100%. Further fiscal measures are expected to be announced in a July budget.

The Bank

In order to support economic activity and meet its inflation objective, the BoE’s Monetary Policy Committee (MPC) cut interest rates to 0.1% in May and voted by a majority of 7-2 to continue with its £200 billion gilt and corporate bond purchase programme, taking the stock of these purchases to £645 billion. The topic of negative interest rates has been discussed by the MPC and is priced into markets by early 2021. While the MPC has been careful not to rule this out, the dissent of two MPC members in favour of increasing asset purchases suggests this policy tool is more likely to be used in the first instance, possibly as soon as this month.


As the clock ticks down towards the July 1 deadline the UK government’s stated position is that it will not request an extension. But this focus has instead shifted to the latest round of negotiations around the future trading relationship. To date limited progress appears to have been made with the previous rounds of talks ending in mutual recriminations. While there are many outstanding issues, major sticking points remain over fishing rights and “level playing field” provisions. Our base case remains that both sides will reach an accord on some form of free trade agreement with zero/low tariffs.

Market implications

Despite concerns about the surge in government bond issuance, in common with other large advanced economies, we expect BoE asset purchases and ongoing investor demand to largely offset this increase. With the prospect of a bare-bones trade deal at the end of the year coinciding with an already challenged growth picture and below-target inflation, it seems likely that the BoE will keep rates at a very low level for the foreseeable future and announce further increases to asset purchases. Consequently, we believe that UK gilt yields and corporate bonds will remain well supported. Conversely, we think this backdrop is less supportive for the British pound given the potential prospect of lower inward investment and portfolio flows.

Legg Mason Key risks and Disclaimers

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

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