UK: Risks skewed to the downside for interest rates going into the referendum – Danske Bank

Chief Analyst, Arne Lohmann Rasmussen at Danske Bank, notes that the UK real GDP expanded 0.4% q/q in Q1 following an increase of 0.6% q/q in Q4 15.

Key Quotes

“The PMI figures bounced back somewhat in May following the decline in April to a three-year low across sectors. While PMI remains above 50 and thus above contractive territory, the UK economy most likely slowed further in Q2, partly due to Brexit uncertainties.

Both GBP yields and money market rates have declined over the past weeks as Brexit concerns reappeared in financial markets following the release of several polls showing a lead for the ‘leave’ camp. The market is currently pricing in roughly 50% probability of a 25bp rate in the UK in 2016. We see risks skewed to the downside for UK interest rates going into the referendum on 23 June as Brexit concerns are likely to remain high as long as the polls continue to indicate a close race between the ‘remain’ and ‘leave’ camps.

In the event of a ‘yes’ vote on 23 June, we see potential for an instant moderate rise in GBP yields across the curve and a steepening of the 2Y10Y curve in the magnitude of 10bp as uncertainty and severe downside risks to the economy are removed.

In our main scenario, assuming that the UK remains in the EU, we expect the BoE to hike interest rates in February 2017. Given the recent indications that the UK economy is slowing, risks are skewed towards a later hike – especially if the economy slows further post the EU referendum. Longer term, we still forecast higher UK interest rates on a medium-term horizon driven by Bank of England rate increases and higher US interest rates. We forecast the five-year UK swap rate at 1.60% in 12M (revised down from 1.65%) and our 6M and 12M yield forecasts are above the forward market across the curve.”