Contrary to widespread pessimism, Morgan Stanley's key contrarian call is that the UK's structural outlook is strong. Adjusted for labor data, recent private sector productivity growth is near 2%, close to US levels. This is driven by robust capital expenditure and potential AI tailwinds, challenging the narrative of long-term stagnation.
While investors focus on high government debt, the UK is undergoing the most severe fiscal consolidation among G7 nations, according to IMF data. Medium-term plans target a deficit below 2% of GDP by 2030, a positive trajectory that seems mispriced by the market, given current high bond yields.
The market is pricing in aggressive Bank of England rate hikes in response to an oil price shock, expecting a repeat of 2022. This view is flawed because, unlike 2022, there is little scope for fiscal stimulus to protect the economy. An inflationary shock would likely trigger a recession, limiting the central bank to only two hikes, far fewer than markets anticipate.
In a global environment where risk premiums are scarce, the UK government bond market stands out for offering significant compensation to investors. For example, the market is pricing a 10-year gilt yield of 6.6% ten years from now—a very high rate that suggests a significant gap between market perception and potential economic reality.