Client Update - 14th February 2025

The Bank of England’s (BoE) decision to cut interest rates by 0.25% last week was widely anticipated, but it still stunned some economists. That’s because Catherine Mann, the Monetary Policy Committee’s arch-hawk, suddenly switched from calling for the cost of credit to stay where it is, to voting for a larger than expected 0.5% cut. Her argument was that Britain’s economic outlook had weakened substantively, putting rate-setters on the back foot. This was backed up by leaks this week allegedly showing the Office of Budget Responsibility report in March will show Rachel Reeves that her stability rule is already under pressure with the BoE growth downgrade and bond market moves removing a large proportion of the £9.9billion margin she had at her budget on 30th October 2024.

Business and consumer confidence has wilted since last summer as the Chancellors’ decision to raise employers’ national insurance contributions in the Autumn Budget has pushed up companies’ costs and triggered a slowdown in hiring.

A survey on Monday showed UK recruiters were reporting the toughest conditions in the job market since the Covid-19 pandemic. Weak economic activity tends to make it harder for businesses to pass on higher costs to consumers, restraining inflation. This all suggests current interest rates are too restrictive. Financial markets are pricing in around three further 25bp cuts before the end of the year. But, given sluggish economic activity, the BoE may need to go further, faster. Indeed, with most UK mortgages agreed at a fixed rate, it will take time for any rate cuts to improve consumers’ cash flow.

Though lower rates would prop up Britain’s sagging economy — and reduce government borrowing costs — it would only soften the symptoms of a deeper malaise. The onus remains on Labour, not the BoE, to reignite animal spirits and outline a fiscally credible path to higher long-term growth.

Now, I promised better news when I wrote last week, and I appreciate this has not been the best start. Therefore, I have a case to make for positivity in the UK, not the economy, but the stocks themselves. This must not be misconstrued as investment advice, but it is something that is occupying our investment teams thoughts right now.

The UK equity market is currently extremely cheap relative to developed market peers. The Price Earnings ratio (P/E = the price you pay for the earnings you receive, often regarded as a good market valuation metric) shows the UK in 2024 had a P/E of 12.2, compared to 25 for the US S&P 500 and 33 for the US tech index the Nasdaq 100. Low valuations have been a persistent feature of the UK equity market since the outcome of the Brexit vote. However, the tides are slowly turning, and positive momentum is building, and the market is slowly beginning to re-rate after almost a decade in the doldrums. Private equity firms and corporations with deep pockets have noticed the UK offers quality investments at bargain prices. There were 32 UK transactions of more than £100 million announced in the first half of 2024, which was the second largest, globally, after the US. Of which 14 and c.£36.7 billion of market capitalisation related to FTSE 250 constituents. Ongoing interest in takeover activity will contribute to upward price pressure across the market.

Other supportive dynamics include a more stable domestic political situation given the new government’s large majority, and whether you love them or loathe them, Labour are here to stay for five years. It is often missed that the UK market also has a very attractive dividend yield. The UK yields above 3.5%, well above the tech focussed US equity market that yields a paltry 1.27%. In a period where interest rates should continue to fall, strong dividends are attractive to investors, lest we forget Warren Buffet’s eighth wonder of the world – the power of compounding. Allowing a strong and growing dividend stream to be used to purchase more units in your portfolio adds significant value over time. If you invested £1,000 into the FTSE 100 on 31 December 1999 and left it alone, it would be worth £1,088 some 20 years later, without reinvesting dividends. That’s not adjusting for the effects of inflation or charges.

However, the picture changes dramatically if you had invested in the FTSE 100 and opted to reinvest the dividends its listed companies pay. In this scenario, if you had invested £1,000 in the FTSE 100 on New Year’s Eve 1999, your investment on the 1st January 2020 would have been worth £2,222. Not a huge return for 20 years of investing, but throughout this period UK shares were somewhat unloved, but you still got paid a healthy dividend whilst you waited for a recovery. Dividends haven’t been in vogue for some years now as zero yielding US technology companies have dominated global returns, but the potential is evidently there.

Despite this, and given the relatively robust performance of UK companies, it has been a surprise that we have not started to see the valuation gap between the UK and other global markets close more quickly. It is also worth reiterating that buying UK stocks does not necessarily mean buying the UK economy, given many London-listed companies generate a significant portion of their revenues overseas – some 75%. Therefore, a weaker sterling versus a strong dollar makes UK equities even more attractive for foreign investors and the companies themselves are making profits in dollars from their overseas income and benefitting from translating these back in cheaper pounds sterling.

That is where I must leave you this week, hoping that if the US growth story starts to run out of steam, our own UK market can start to thrive and flourish and better times would certainly be ahead. For investors at least. Do have a good weekend.