Opportunities in Bonds and Undervalued Equities

The UK economy in 2025 is a study in contradictions: tepid growth, persistent inflation, and fiscal tightening with compelling investment opportunities. For discerning investors, this landscape offers a chance to capitalize on undervalued assets, particularly in fixed income and equities.

The UK’s economic growth remains subdued, with the IMF projecting a modest 1.1% expansion for the year. Inflation has eased from its 2022 peak but persists above the Bank of England’s 2% target, registering at 2.6% in March. The Bank’s cautious approach, including two rate cuts bringing the base rate to 4.25%, reflects the delicate balance between stimulating growth and containing inflation.

Fiscal policy adds another layer of complexity. The government’s commitment to reducing public debt, which hovers around 100% of GDP, limits its ability to inject significant stimulus into the economy. This fiscal restraint, while aimed at long-term stability, may dampen short-term growth prospects.

Fixed Income: Seizing High Yields Amid Inflation Risks

UK gilts present a rare opportunity, offering 10-year yields around 4.65%, levels not seen since 2008. Real yields have turned positive, making gilts attractive for income-focused investors. However, the specter of persistent inflation could erode these returns, and any resurgence in price pressures may lead to further yield increases, negatively impacting bond prices.

Corporate bonds mirror this trend, with investment-grade yields in the 5 to 6% range. While offering higher income, investors should conduct thorough credit analyses, as economic uncertainties could elevate default risks. Moreover, the Bank of England’s quantitative tightening strategy, involving large-scale gilt sales, has been criticized for pushing up bond yields and increasing government debt servicing costs. This approach may impose significant and long-lasting costs on UK taxpayers.

Equities: Undervalued Gems with Sectoral Strengths

UK equities are trading at historically low valuations while offering access to a diverse range of companies benefiting from underappreciated UK economic strengths.  The FTSE 100’s forward P/E ratio stands at approximately 13.1x, significantly lower than the S&P 500’s 22.8x. Additionally, the FTSE 100 offers a dividend yield around 3.7% (vs S&P’s 1.3%), appealing to income-focused investors.

Sector Highlights:

Energy & Materials: Benefiting from sustained commodity prices, companies in these sectors are generating strong cash flows. 
Financials: Higher interest rates have improved bank margins, though prolonged high rates could increase loan defaults. 
Consumer Staples & Healthcare: These sectors provide defensive qualities amid economic uncertainties, with stable earnings and dividends. 

However, sectors tied to domestic consumption, such as retail and housing, may face headwinds due to higher borrowing costs and potential regulatory changes.

Housing Market: Stabilization Amid Supply Surge

The UK housing market shows signs of stabilization. The average asking price reached a record £379,517 in May, marking a 0.6% monthly increase. However, this growth is tempered by the highest number of homes for sale in a decade, increasing buyer choice and competition. Knight Frank projects a 3.5% average house price increase for 2025.

Investment Considerations: Balancing Risks and Rewards

Opportunities:

Bonds: Elevated yields offer income potential, especially if inflation continues to decline. 
Equities: Attractive valuations and strong dividend yields, particularly in global-facing sectors. 

Risks:

Inflation: A resurgence could impact bond prices and consumer spending. 
Political Uncertainty: Upcoming elections may introduce policy shifts affecting various sectors. 
Global Trade: External factors, including US trade policies, could influence the UK’s economic trajectory.

This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.