Several factors are driving this newfound optimism. First, the energy shock, while painful, has not been as catastrophic as the worst-case scenarios predicted. Oil prices stabilised below the panic-inducing $120-a-barrel mark, and while they remain elevated, the global economy is showing signs of absorbing the blow without descending into a full-blown recession. Second, and perhaps more importantly for the UK, the domestic data has been so consistently weak that it is becoming impossible for even the most hawkish members of the Monetary Policy Committee to justify aggressive tightening. Wage growth is finally moderating, and the labour market is showing distinct signs of slack. The argument that the UK faces a “wage-price spiral” is looking increasingly threadbare. The real spiral seems to be a “cost-of-living downward spiral.”
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For the City’s traders, this new outlook has triggered a rotation in portfolios. The trade of the moment is to buy duration, betting that bond yields have peaked for this cycle. Sectors that were battered by the expectation of higher rates, such as real estate investment trusts and highly leveraged utilities, have seen a tentative rebound. It is a classic “relief rally” in the interest-rate sensitive corners of the market. However, the more seasoned hands in the Square Mile are counselling caution. This is still a market that is trading on headlines, not on fundamentals. The situation in the Middle East remains volatile. One errant drone strike or a breakdown in the ceasefire could send the oil price spiralling back up and, with it, those interest rate expectations. For now, the City is breathing a sigh of relief and betting on the ‘one and done’ scenario. It is a gamble on peace and economic weakness, a strange combination indeed. If the gamble pays off, 2026 might just be the year the interest rate nightmare finally begins to recede. If it fails, the City’s analysts will be reaching for their erasers once again.
