Moderate recovery driven by easing headwinds

The UK has experienced very downbeat economic activity over the past two years and is still bordering on possible negative growth. We expect growth to return to positive in Q1 as a moderate recovery sets in. For 2013 as a whole we expect growth of 1.1% and for 2014 we project growth of 1.7%.

A fading euro crisis, increasing house prices in the US and accelerating growth in China are all contributing to a more favourable global macro picture. Net exports are expected to support the UK recovery after having weighed down growth last year.

Going forward, we expect private consumption to drive growth as lower inflation and recent improvement in the labour market will support real income growth. Lower uncertainty and improving credit conditions should ensure an improving environment for investments. We expect fiscal consolidation to weigh on growth again as we enter 2014.

In the current environment, we do not see BoE cutting rates or adding to the QE programme. If the UK economic activity turns out weaker than our main scenario, additional QE will most likely be the MPC’s preferred tool. As the date for when Mark Carney replaces Sir Mervyn King moves closer, the recent debate on new policy measures and guidance could receive more attention.

10Y Gilt yields should mirror international bond markets and stay range bound from current levels in H1 13 - and eventually the curve should steepen from the long end. A potential downgrade in 2013 is not expected to have any material effect on yields.

Euro optimism and risk of new easing are likely to push EUR/GBP higher in 2013 and we expect EUR/GBP to trade at 0.84, 0.85 and 0.82 on a 3, 6 and 12-month horizon. (spot:0.83).