Weekly Comment: UK stocks hit new record highs

Market overview – Richard Carter, Head of Fixed Interest Research

Global equities recovered last week, boosted by a benign US inflation report, sending the UK stock benchmark to its highest closing level on record. The MSCI All Country World index rose 2.6% (1.7% YTD) while government bond yields in the US, UK and Germany all declined.

United States

A drop in the US core consumer price index was well received by investors, sending stocks higher. The core year-on-year reading of 3.2% marked a small decrease from the 3.3% prior print. Although the headline number showed an expected annual increase to 2.9% from 2.7%, markets seemed to react more to the core figure which strips out volatile components such as food and energy prices.   

US stocks rose 2.9% (2.0% YTD) with value stocks outpacing growth shares by the widest weekly margin since September. Small caps (4.0%, 2.1% YTD) outperformed large caps and tech-heavy indices slightly underperformed (2.4%, 1.7% YTD).  Strong earnings announcements boosted financials with large banks posting rising profits in Q4.

United Kingdom

Inflation was also in focus in the UK, as the annual consumer price index dipped to 2.5% from 2.6%. The reduction increased expectations that the Bank of England could cut rates at their next policy meeting, although this is not a foregone conclusion. Services inflation fell to its lowest level since 2022, coming in at 4.4%, while core inflation dropped to 3.2% from 3.5%.

The data helped support the gilt market, with the 10-year gilt yield down 18 basis points on the week to end at 4.66% (+9 basis points YTD). UK equities enjoyed a good week, rising 3.1% (4.1% YTD) and the pound was pretty stable against the US dollar at US$1.22.   

Europe ex UK

Continental European stocks also moved higher, as the MSCI Europe ex UK rose 2.4% (3.7% YTD). German (3.4%, 5.0% YTD), French (3.8%, 4.6% YTD) and Italian (3.4%, 6.1% YTD) stocks outperformed as equities from the Eurozone’s largest economies reacted positively to the inflation data and raised hopes for more interest rate cuts.

The European Central Bank (ECB) minutes showed that rate setters believe cautious and gradual further reductions in the base rate are warranted. Derivatives markets are expecting another 25 basis point reduction at the next ECB meeting at the end of the month.  

New peak for UK equities

Large-cap UK stocks ended last week at their highest ever level, surpassing the previous peak from May 2024. Strong performance among the sectors that carry the larger weights in the index like oil majors and banks, the ongoing tailwind of stock buybacks and favourable currency moves in recent weeks have all played a part in the latest push higher.

Since the US election in early November the pound has fallen from around US$1.30 to the low US$1.20s, largely as a result of US dollar strengthening in the response to the expected policies of the Trump administration. This decline has provided a boost to UK equities given that the majority of revenues among companies in the UK index are generated in non-sterling terms.

Stock buybacks continue to provide support for UK equities, with 44% of large companies in the UK reducing their share count by at least 1% last year, comfortably more than the 39% equivalent in the US.

Lower inflation data also raised hopes of further interest rate cuts from the Bank of England going forward.  The primary drivers of inflation in December were rising costs for transportation and household services, whilst clothing, restaurants and hotels saw a downward contribution.

Services inflation, which stood at 4.4%, down from 5% in November, remains a major focus as wage inflation stays well above the 2% target. Employers’ responses to the autumn budget suggest that cuts to headcount and price hikes are the most likely outcomes. While these measures may eventually dampen wage inflation, in the near term, public sector pay rises of around 5%-6%, combined with ongoing labour shortages in parts of the service economy, continue to drive elevated levels of wage growth. With wages accounting for around 60% of the costs within the service sector, this remains a significant obstacle to further interest rate cuts.

At its December meeting, the Bank of England also highlighted rising risks from geopolitical tensions and trade policy uncertainty. With energy prices increasing due to further pressure on European gas supplies amidst a cold weather snap and ongoing global trade frictions, it is unsurprising that consumers are raising their inflation expectations in the year ahead. This shift in expectations can alter consumer spending decisions and become a more potent driver of future inflation.

Markets are sceptical about the prospect of further rate cuts in the UK before May, pricing in less than two 25 basis point cuts for 2025 as a whole. The likely absence of interest rate cuts in the near term add to the headaches at the Treasury as growth is likely to remain anaemic.

While the most likely outcome remains weak growth and slowing inflationary pressure as we move through the year, the increasing frailty to the UK economy suggests that the risk of recession, though still modest, appears to be increasing.

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