UK: Downside risks to growth, inflation fears overblown, yields too high

Inflation remains elevated but is likely to turn lower before long while downside growth risks continue to mount. We are still long 2-year Gilts (i.e., lower yields) as we think inflation fears are overdone.

Another upside inflation surprise in this month’s release doesn’t have us worried given most inflation leading indicators are turning lower. For example, CBI selling prices have fallen sharply while the survey of hospitality firms’ price expectations have hit a new multi-year low.

On the growth front, many leading indicators point to a continued slowdown, including our growth LEI and the CBI Growth Indicator (see Chart Collection). The latest employment data remain weak in the aftermath of employment tax hikes, even if this weakness is somewhat overstated given consistent upward revisions and a shift towards self-employment.

UK real yields are still too high given signs of weakness in the labor and housing markets. Our proxy for the neutral rate – 5y5y “real” OIS – edged higher and is still near the highest level in at least a decade.