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Market underpricing UK rate hike risk
ETF Securities FX Research: Market underpricing UK rate hike risk
Highlights
- Upside potential for GBP despite the mixed message from the Bank of England (BOE) keeping volatility elevated. The market is underpricing the chance of rate hikes.
- Rising real interest rates will continue to be supportive of Sterling (GBP) in coming months.
- Positioning for GBP against the USD has rebounded to historical averages, but remains depressed against the Euro, which is an overcrowded trade.
One year on from the last rate cut, the Bank of England (BOE) has kept rates on hold, with the MPC voting 6-2 in favour of the decision (roughly the same as last month). Although policy remains unchanged, GBP should remain supported by what is expected to be a tighter policy path in 2017/2018. Indeed, Governor Carney has indicated that policy may need to be tightened at a faster rate than the market is currently pricing.
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Currency volatility has made a persistent move upward in recent weeks, largely to the detriment of the Pound. A relatively more hawkish policy stance by the UK central bank will support the Pound as Brexit negotiation outcomes remain obscure. As we believe inflation will remain stubbornly high, real interest rate differentials will become an increasingly important indicator for FX markets. Rising real interest rate differentials in the US continue will remain a supportive influence for GBP.
Cautious Bank of England
While a decidedly cautious tone was struck by Governor Carney at the BOE press conference last week, tighter policy is coming: if UK economic growth continues at the rate the BOE has forecast, the market is underpricing the amount of policy tightening that is necessary. The market is only pricing in a 50% chance of a rate hike by end March 2018.
The UK economy remains somewhat mixed after the EU Referendum, with the unemployment rate at pre-crisis levels and evidence that both the manufacturing and services sector are growing in a robust manner. However, negative real wage growth and plummeting consumer confidence remain a constraint for the household sector.
The reason for the additional BOE stimulus (a rate cut and additional asset purchases) a year ago was appropriately forward looking, as Governor Carney quoted; ‘the weaker medium-term outlook for activity…[will lead to] an eventual rise in unemployment’. The UK central bank seems to have become less proactive since then, highlighting that the UK is currently ‘in the teeth’ of the squeeze for households and both consumption growth and business investment will improve further in coming months.
Inflation pressure mounts
Meanwhile, inflation remains elevated in the UK and well above the BOE’s target. The longer this continues, the greater the chance of expectations becoming unanchored, especially if energy price gains are sustained. While inflation hasn’t surprised to the upside in recent months, market implied inflationary expectations remain elevated (well above a year ago), and above other major economies. Inflation is expected to remain above the BOE target for the entire BOE forecast horizon, a period of three years. The BOE’s credibility is on the line, because it appears to be becoming less proactive with policy and reacting to events that have, and may not, occur i.e. a hard Brexit.
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Current BOE policy remains extremely accommodative. There may be uncertainties around the Brexit negotiations, but we believe emergency interest rate settings do not seem appropriate. Indeed, Governor Carney notes that there are limits to what monetary policy can do relating to the Brexit situation. We expect that negotiations surrounding Brexit will remain in flux and given there is unlikely to be significant progress made, the worst-case scenario has already been digested by the FX market. In turn, the BOE is likely to unwind their Brexit induced rate cut from last year in H2 2017.
The key sentence in the BOE’s Monetary Policy Summary report is ‘The combination of high rates of profitability, especially in the export sector, the low cost of capital and limited spare capacity, supports investment by UK firms over the forecast period, offsetting the effect of continued uncertainties around Brexit’. Surely if the economic uncertainty surrounding Brexit is offset, then the 2016 rate cut and additional stimulus should be unwound…if not in 2017, then when?
Just a day after the meeting, the mixed messages to the market continued: Deputy Governor Broadbent, who voted to keep rates unchanged, commented that ‘there may be some possibility for interest rates to go up a little bit’. This is reminiscent of the previous meeting that was interpreted dovishly by the market, only for the ‘doves’ to signal tighter policy was an issue that needed discussion only days later. Mixed messages are an impediment for economic stability and consumer and business confidence.
Meanwhile, gradually tighter Fed policy is already priced into the USD. Although we expect the broad USD index is in a bottoming process, a move higher will be gradual and predicated on political risks fading, something that will take time given investor focus on the incompetence of the Trump administration. Accordingly, the more hawkish policy that we expect from the BOE will bring forward expectations of a rate hike in the fourth quarter and forcing GBP higher in H2 2017.
How the market is positioned
GBP positioning has rebounded against the USD, in line with the recent more bullish performance and is now at levels consistent with longer-term historical averages.
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Against the Euro, GBP looks extremely attractively priced – hovering around record low levels. We feel that the Euro strength is at risk of an unwind as the ECB remains conservative in its policy approach in the face of the elevated Euro. Compared to historical long-term averages, positioning for the Euro highlights a very overcrowded trade.
The bottom line…
The mixed messages from the BOE are confusing investors and keeping GBP volatility elevated. We expect the BOE to unwind its Brexit-induced rate cut of 2016 in the second half of 2017, but not to remove its balance sheet stimulus from the economy. GBP will benefit from tighter policy settings. We believe that GBP will consolidate above the 1.30 level and potentially break to the upside, approaching 1.35.
For more information contact:
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
Important Information
This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
2024 was a landmark year for bitcoin, solidifying its role as a fully institutionalised asset class.
Institutional inflows into physical bitcoin exchange-traded products (ETPs) reached nearly $35 billion globally, signalling a major shift in how traditional investors view crypto. As bitcoin continued to enhance portfolios’ risk-return profiles, more institutional investors followed suit, reshaping the financial landscape.
Looking ahead, 2025 promises to bring exciting developments across the crypto ecosystem. Here are the top five crypto trends to watch.
Fear of being left behind
The era of bitcoin as a niche investment is over. Institutional adoption is creating a ripple effect, forcing hesitant players to reconsider. Portfolios with bitcoin allocations are consistently outperforming those without, highlighting its growing importance.
Figure 1: Bitcoin in a multi-asset portfolio
| 60/40 Global Portfolio | 1% Bitcoin Portfolio | 3% Bitcoin Portfolio | 5% Bitcoin Portfolio | 10% Bitcoin Portfolio | MSCI AC World | Bloomberg Multiverse | Bitcoin | |
| Annualised Return | 5.77% | 6.46% | 7.83% | 9.20% | 12.57% | 9.07% | 0.56% | 56.24% |
| Volatility | 8.79% | 8.86% | 9.14% | 9.62% | 11.42% | 13.94% | 5.05% | 67.28% |
| Sharpe Ratio | 0.48 | 0.55 | 0.68 | 0.79 | 0.96 | 0.54 | -0.20 | 0.81 |
| Information Ratio | 1.01 | 1.01 | 1.01 | 1.00 | ||||
| Beta | 70% | 71% | 73% | 75% | 81% | 100% | 24% | 181% |
Source: Bloomberg, WisdomTree. From 31 December 2013 to 30 November 2024. In USD. Based on daily returns. The 60/40 Global Portfolio is composed of 60% MSCI All Country World and 40% Bloomberg Multiverse. You cannot invest directly in an index. Historical performance is not an indication of future performance and any investment may go down in value.
With bitcoin’s ability to noticeably improve portfolios’ risk-return profiles, asset managers face a clear choice: integrate bitcoin into multi-asset portfolios or risk falling behind in a rapidly evolving financial landscape. In 2025, expect the competition to heat up as clients demand exposure to this powerhouse cryptocurrency.
Expanding crypto investment options
In 2024, regulatory breakthroughs opened the doors for physical bitcoin and ether ETPs in key developed markets. This marked a critical step towards making cryptocurrencies mainstream, providing seamless access to institutional and retail investors alike.
Figure 2: Global physical crypto ETP assets under management (AUM) and 2024 net flows
Source: Bloomberg, WisdomTree. 02 January 2025. Historical performance is not an indication of future performance and any investment may go down in value.
In 2025, this momentum is expected to accelerate as the crypto regulatory environment becomes more friendly in the United States and as key developed markets follow Europe’s lead and approve ETPs for altcoins such as Solana and XRP. With their clear utility and growing adoption, these altcoins are strong candidates for institutional investment vehicles.
This next wave of altcoin ETPs will expand the diversity of crypto investment opportunities and further integrate cryptocurrencies into the global financial system.
The maturing of Ethereum’s layer-2 ecosystem
Ethereum’s role as the backbone of decentralised finance (DeFi), non-fungible tokens (NFTs), and Web3 is unmatched, but its scalability challenges remain a hurdle. Layer-2 solutions—technologies such as Arbitrum and Optimism—are transforming Ethereum’s scalability and usability by enabling faster, cheaper transactions.
In 2025, Ethereum’s recent upgrades, such as Proto-Danksharding (introduced in the ‘Dencun’ upgrade), will drive layer-2 adoption even further. Innovations like Visa’s layer-2 payment platform leveraging Ethereum for instant cross-border transactions will underscore the platform’s evolution.
Expect Ethereum’s layer-2 ecosystem to power real-world use cases ranging from tokenized assets to decentralised gaming, positioning it as the infrastructure of a truly scalable digital economy.
Stablecoins: bridging finance and blockchain
Stablecoins are becoming indispensable to the global financial system, offering the stability of traditional assets with the efficiency of blockchain. Platforms such as Ethereum dominate the stablecoin landscape, hosting stablecoin giants Tether (USDT) and USD Coin (USDC), which facilitate billions in daily transactions.
Figure 3: Key stablecoin chains
Source: Artemis Terminal, WisdomTree. 05 January 2025. Historical performance is not an indication of future performance and any investment may go down in value.
As we move into 2025, stablecoins will increasingly interact with blockchain ecosystems such as Solana and XRP. Solana’s high-speed, low-cost infrastructure makes it ideal for stablecoin payments and remittances, while XRP Ledger’s focus on cross-border efficiency positions it as a leader in global settlements. With institutional adoption rising and DeFi applications booming, stablecoins will serve as the backbone of a seamless, interconnected financial ecosystem.
Tokenization: redefining ownership and revolutionising finance
Tokenization is set to redefine how we think about ownership and value. By converting tangible assets like real estate, commodities, stocks, and art into digital tokens, tokenization breaks down barriers to entry and creates unprecedented liquidity.
In 2025, tokenization will expand dramatically, empowering investors to own fractions of high-value assets. Platforms such as Paxos Gold and AspenCoin are already showcasing how tokenization can revolutionize markets for gold and luxury real estate. The integration of tokenized assets into DeFi will unlock new financial opportunities, such as using tokenized real estate as collateral for loans. As tokenization matures, it will transform industries ranging from private equity to venture capital, creating a more inclusive and efficient financial system.
For the avoidance of any doubt, tokenization complements crypto by expanding the use cases of blockchain to include real-world applications.
Looking ahead
2025 is set to be a defining year for crypto, as innovation, regulation, and adoption converge. Whether it is bitcoin cementing its position as a portfolio staple, Ethereum scaling for mainstream use, or tokenization unlocking liquidity in untapped markets, the crypto ecosystem is poised for explosive growth. For investors and institutions alike, the opportunities have never been clearer or more compelling.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
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