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MARKETS LIVE BLOG: UK Assets Outlook Amid 2.3% Inflation Drop and HSBC Upgrade

UK Prime Minister Calls Elections Amid 2.3% Inflation, HSBC Upgrades UK Equities to Overweight with 5.7% EPS Growth Forecast

By Athena Xu

5/23, 04:56 EDT

Key Takeaway

  • UK Prime Minister Rishi Sunak calls for elections amid political challenges and a recent drop in inflation to 2.3%.
  • HSBC upgrades UK equities to overweight, forecasting 5.7% EPS growth for FTSE 350 in 2024, driven by favorable conditions.
  • Mixed economic indicators: services sector weakens while manufacturing shows growth; gilts hold losses post-PMI data release.

UK Political Landscape

UK Prime Minister Rishi Sunak has made the unprecedented decision to call for elections despite facing significant political challenges. Sunak's optimism stems from the recent drop in headline inflation to 2.3%, which is close to the Bank of England's 2% target. This achievement is seen as a victory for Sunak, a former hedge fund manager. However, the decision to go to the polls now raises questions. If Sunak believed that the economic situation was genuinely improving, he might have waited another six months to capitalize on further positive developments. His decision suggests he may anticipate worsening conditions.

Sunak faces several hurdles, including inflation that remains higher than forecasted and lingering investor skepticism following the Liz Truss debacle 20 months ago. Additionally, public perception of the economy remains bleak, with many Britons feeling that the economic situation is worse than official figures indicate. Investors' confidence in the UK remains low, and Sunak has not significantly altered this sentiment. The upcoming elections will test whether the market has more confidence in Sunak or a potential Labour government led by Keir Starmer.

UK Equities Outlook

The UK equity market is experiencing a resurgence, driven by favorable sector exposure and low stock valuations. The decline in inflation to a nearly three-year low has created a positive economic backdrop, potentially marking the beginning of a revival for British stocks. HSBC strategists, led by Edward Stanford, have upgraded UK equities to overweight and raised their EPS growth forecast for the FTSE 350 to 5.7% in 2024, compared to the consensus of 3.4%. They attribute this upgrade to several factors, including valuation, sector composition, shareholder returns, and the end of the long-term structural overhang of UK pension fund selling UK stocks.

"The time is now," say the HSBC strategists, emphasizing the current favorable conditions for UK equities. This optimistic outlook suggests that the UK equity market has the catalysts in place to extend its rally, providing a potential opportunity for investors.

Mixed Economic Indicators

The latest UK PMI numbers for May present a mixed picture. Gilts held losses after the data release, particularly at the front end of the curve. The services industry, which is a dominant part of the UK economy, showed unexpected weakness, hitting a six-month low and indicating a loss of recovery momentum. However, the manufacturing sector showed surprise strength, returning to growth.

The survey also revealed that services firms experienced the weakest cost pressures in over three years. This development offers some comfort to Bank of England rate-setters who are looking for signs of cooling inflation in the UK's largest sector. The mixed economic indicators highlight the complexities of the current economic environment, with both positive and negative signals for investors to consider.