With all eyes on the Bank of England’s monetary policymakers, markets in the UK could be in for a turbulent few months. Most market analysts accept that interest rates are bound to rise further, but exactly where they will peak in this cycle is still a bone of contention.
Bob Semple, market strategist at Deutsche Bank, predicts trading in both bond and equity markets will be quite volatile over the next six months. Strong growth in the UK economy, signalled by rising house prices and labour market data rather than core GDP numbers, is likely to send the bond market into a panic about inflation, he says.
“Both markets will have a fairly rough ride, and only when the MPC [monetary policy committee of the Bank of_England] is perceived to have slowed inflation will they become more comfortable,” says Semple.
He says he expects the FTSE 100 index to reach just 7,000 by the end of the year, hovering around 6,000 mid-year. This means a fall from mid-January’s level of around 6,500. But because of the volatility, giving any concrete forecast for the FTSE is a dangerous game, he cautions.
Merrill Lynch UK equity strategist Khuram Chawdhry also forecasts more downside for the UK market over the next six months, with the FTSE dropping to around 6,300 by the middle of the year. Costlier credit on both sides of the Atlantic will weigh on the market's mood, he says.
Commodities prices are rebounding, sending a signal that growth is strong, he says. “Interest rates in the US and UK will go up – although inflation is still relatively benign, central banks are acting to pre-empt any inflationary pressure,” says Chawdhry.
However, Paul Sheehan, UK equity fund manager at Dresdner RCM Global Investors, is optimistic for stocks this year. “We think the FTSE will be north of 7,000 mid-year and then probably push up further after that,” he says.
“There is a lot of cash around, and a lot of liquidity to come out from bonds into equities,” he says. Valuations are already considered by some to be sky-high, but analysts at Dresdner believe equities can sustain a higher and higher valuation because interest rates are at their peak, or near it, says Sheehan.
Opinions are divided on which industrial sectors will appeal to buyers this year. Sheehan predicts technology and other growth companies along with media companies will form the main focus of the market’s rally.
“There is a lot of growth to come through in the telecoms sector which is not yet fully reflected in the prices... software_firms have come through Y2K relatively unscathed and we think their order books will pick up,” says Sheehan.
Deutsche Bank’s Semple agrees technology and telecommunications stocks, the darlings of the market last year, will continue to outperform, particularly stocks which have a good story behind them. But at some stage these businesses will have to deliver real profits, he says. If two years down the line they have still failed to do this, the whole market sector could tumble, he says.
But trading patterns could change this year. Disparity between sectors is likely to shrink, says Semple, as the market searches for value. Those sectors which underperformed last year should attract buyers for this reason, he says.
Chawdhry is less positive for media, telecommunication and technology stocks this year, saying this type of stock usually performs well in an environment of slow growth. “So we would generally favour cyclicals,” he says. Mining and consumer cyclicals such as brewing could perform well, he says.
Banks are currently cheap by historical standards, and the prospect of consolidation in the sector, and share buy-backs, should draw buyers into the sector, he says. Mergers, such as the proposed NatWest and Bank of Scotland deal have the potential for large scale cost cutting, and banks’ electronic and online financial packages should also create savings for the institutions, he says.
In the UK gilts market, Geoffrey Dicks, chief economist at Greenwich NatWest, predicts 2000 will be a year of two halves.
Though there is little doubt among economists that UK interest rates are still on their way up, most believe rates will peak at a lower level than the market is expecting, he says. Greenwich NatWest forecasts base rates will peak at 6.25%, which, says Dicks, is at the low end of predictions. The market, however, is pricing in rates of up to seven or 7.5%.
Semple sees interest rates peaking at 6.5% – well short of the 7.5% peak of the last interest rate cycle.
“Assuming the economists are rights, at some stage the markets will rethink,” says Dicks.
In the first half of the year, 10-year gilt yields will rise as far as 6%, prompted by rate hikes from the Bank of England. But in the second half once market players realise they have priced in too much, yields will fall back to 5.6 or 5.7%, he says.

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