Commodities more likely than sterling to boost UK equities

It might seem surprising that the UK stock market has outperformed its peers recently, given the ongoing pressure on commodity prices. After all, the share of firms listed in the oil & gas and basic materials sectors is relatively large in the UK (13%, compared to 10% in the euro-zone, 9% in the US and 6% in Japan). This can largely be explained by the weakness of sterling - in US dollar terms, the UK stock market has underperformed other major developed stock markets since the pound's recent peak in mid-November.

"We expect sterling to depreciate further against the US dollar, although not against the euro and the yen. Meanwhile, we expect commodity prices to recover. Against this backdrop, we think equities in the UK will outperform those in the US, but not those in the euro-zone and Japan", says Capital Economics in a research note.

On a trade-weighted basis, sterling has fallen around 5% since mid-November, making it the worst performing major currency bar the Canadian dollar over this period. Sterling's weakness seems largely due to a reassessment of the prospects for monetary policy in the UK relative to its trading partners, prompted by the realisation that a referendum on the UK's membership of the EU could happen as early as June, as well as softer UK economic data. The minutes from Thursday's MPC meeting also gave little indication that the MPC is in any hurry to tighten policy.

"We think a more likely source of support for UK equities is a recovery in commodity prices. Granted, with sentiment so poor, oil prices could yet fall further. But we think that supply cuts will see the price of Brent recover to around $45 per barrel by the end-2016", added Capital Economics.