Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Sterling erases post-Brexit discount versus the euro
John J. Hardy
Chief Macro Strategist
Summary: As Europe’s economy struggles, fresh fiscal policy winds are blowing in the UK, driving sterling back to levels versus the euro not seen since before Brexit.
The UK outlook is as constructive as ever in the post-Brexit era. That is, it is the most positive relative to the sick man of Europe, which is, well…Europe, or at least the core Eurozone countries, France and Germany. Fresh fiscal policy winds are blowing in the UK, where the new UK Labour government announced budget priorities ahead of 2025 that avoided the most growth-damaging types of tax hikes on income, while trimming the least productive public sector spending in moving to shrinking its deficits. By cutting unproductive subsidies like winter fuel aid for pensioners, encouraging investment in the property and manufacturing sectors and raising incomes for public sector workers, the UK is primed for solid nominal growth in the years ahead, keeping the Bank of England policy rate at a high level compared to major global peers.
On the European continent, the situation couldn't be more different. France has a dysfunctional government that is mired in a five-year exercise of getting its out-of-control budgets in order. It has already announced growth-killing taxes on personal and corporate income and austerity. Shield your eyes! Meanwhile, Germany remains the sickest of the sick in Europe, unwilling to debt finance desperately needed domestic investment in housing and infrastructure that it could easily afford. Its former economic model of cheap Russian energy inputs to drive its huge industrial base and manufactured exports lies in ruins. And its non-luxury car producers have been rendered uncompetitive by both high energy input costs and China running away with new EV battery technology and gobbling up a dominant global export share in the critical auto sector. Germany must find a new way – but that is perhaps an outrageous prediction for 2026…
In 2025, sterling rises through 1.27 versus the euro, the level it traded ahead of the Brexit referendum, thus erasing its entire post-Brexit vote discount.
Potential market impact: Encouraging domestic investment and a more robust growth outlook support sterling versus the flailing euro, seeing the Euro/Sterling rate fall as low as 0.7500, below the rate the day before the Brexit vote at 0.76. The UK FTSE 100 posts a strong performance.
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