Global Insight 2025 Outlook: United Kingdom

By Frédérique Carrier, Rufaro Chiriseri, CFA and Thomas McGarrity, CFA

United Kingdom equities

The UK economy fared better than widely expected by investors in 2024,
though the outlook remains subdued with consensus GDP growth of 1.3 percent
estimated for 2025. The likely imposition of U.S. tariffs would negatively
impact the UK economy, in our view, but the direct impact may be less than
what EU countries may suffer. UK exports to the U.S. are only two percent of GDP,
compared to four percent for Germany. Besides, the UK economy is more
services-oriented than those of its neighbors.

But from our vantage point, the UK economy is also likely to suffer from
an indirect impact. Exports to the EU may decline as the region’s overall
growth is restrained by trade uncertainty. Even after Brexit, the EU
remains the UK’s most important export market by far, accounting for 42 percent
of all UK exports. Moreover, proposed U.S. tariffs and any potential
retaliation may dampen UK business confidence.

The government may not have much room to manoeuvre to offset a
tariff-related negative growth shock, having used much of its fiscal
leeway in the recent budget. The Bank of England (BoE), with an eye on
sticky services inflation, may be reluctant to loosen monetary policy too
quickly.

The FTSE All-Share Index tends to perform relatively well during global
downturns—not our base case forecast—thanks to its high relative exposure
to defensive sectors such as Health Care, Utilities, and Consumer Staples.
Conversely, it tends to lag in periods when growth sectors are favoured
due to its low exposure to Technology in particular.

UK valuations remain close to all-time low levels compared to other
markets. The FTSE All-Share Index is trading well below its relative
long-term median price-to-earnings ratio versus global developed markets,
even accounting for sector differences.

UK equities valuation at 10-year low relative to global equities

FTSE All-Share 12-month forward price-to-earnings ratio relative to the
MSCI World Index

The line chart shows the valuation of the FTSE All-Share Index
relative to the MSCI World Index since November 2014. Since reaching a
high of 0.97x in 2016, the relative valuation has steadily declined
and is now at a 10-year low of less than 0.6x.

Source – RBC Wealth Management, Bloomberg; data through 11/13/24

Overall, we recommend holding an Underweight position in UK equities, but
we believe select quality large caps remain attractive long-term
opportunities as they trade at a valuation discount to peers listed in
other markets. We favour stocks exposed to UK consumer spending, which
should benefit from Bank of England interest rate cuts over the next 12
months.

United Kingdom fixed income

The Bank of England (BoE) is facing more palatable incoming inflation
data, albeit with risks lying ahead. According to the Office of Budget
Responsibility, the budget will raise GDP growth, but also reignite
inflation above the BoE’s target over the 2025–2029 forecast period.
Though the BoE refrained from remarking on the effects of stimulative
fiscal policy and potential U.S tariffs on the economy, the message was
clear in its November projections, in our view. According to the central
bank’s forecasts, inflation should return to target in Q1 2027, a year
later than suggested in the August estimates.

Markets are pricing in a 4.25 percent Bank Rate in H1 2025, which seems
reasonable if incoming inflation data is broadly in line with the BoE’s
forecast. Policy easing could be limited in 2025 if there are persistent
upside inflation surprises fueled by tariffs and government spending,
relative to BoE forecasts.

The Debt Management Office’s forecast over the next few years shows that
gross Gilt issuance will remain above the historic 10-year averages
(excluding 2020, a year with heavy issuances due to the COVID-19
pandemic). Gilt demand remains robust, even with the overhang of £142
billion of additional borrowing on the horizon. We think the fiscal and
supply glut risks are largely priced in over the near term, with 10-year
Gilt yields at one-year highs, and we have favored adding duration in
portfolios.

Corporate bond yield compensation for duration is around one-year
averages, thanks to higher Gilt yields. While all-in yields look
compelling to us, spreads have narrowed markedly, shifting further into
expensive territory, and we believe the risk of widening from current
tight levels is high. A potential headwind lies ahead for corporates that
struggle to pass on increased labour costs due to larger employer national
insurance contributions and a higher minimum wage. We are cautious and
selective on allocations in the near term and favour allocations in
Consumer Staples, Industrials, and Financials.

UK bond yields near 2024 peak levels

The line chart shows the yield of the Sterling Aggregate Corporate
Index and Sterling Gilts Index from January 2024 through November
2024. Corporate yields are currently at 5.58%, compared to 5.23% in
January and a high of 5.77% in May. Gilt yields are currently at
4.56%, compared to 3.90% in January and a high of 4.61% in May.

Source – RBC Wealth Management, Bloomberg; yields represented by the
Bloomberg Sterling Aggregate Corporate Index and Sterling Gilts Index;
data through 11/13/24

View the full Global Insight 2025 Outlook here