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Oct. 19, 2021, 8:48 a.m. EDT

Buy U.K. banks because interest rates are going up, says UBS

By Barbara Kollmeyer

It’s time to get behind the prospect of higher U.K. interest rates by buying banks.

So say analysts at UBS in a note to clients on Tuesday, a day after U.K. two-year bond yields (XTUP:BX:TMUBMUSD02Y) spiked to a level not seen in more than a year. The push higher came amid hawkish comments from Bank of England Governor Andrew Bailey, who said monetary policy officials “will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations.”

Here’s the argument for domestic bank exposure from a team of analysts at UBS led by Jason Napier:

“A steepening UK yield curve implies 115 bps of BoE hikes in the next 12 months, a significant earnings tailwind. But bank stocks aren’t keeping up with historical correlations with the curve: investors appear doubtful the BoE will move that far, that fast, and are concerned about inflation-driven pressure on household finances.”

Napier and the team don’t expect higher interest rates to equal “noticeably” higher defaults and see lower impairment charges in 2021/22 than consensus, which will lead to more significant capital generation and payouts.

U.K. banks, meanwhile, are trading at a 20% discount to the European bank average at 7.7 times 2022 earnings per share. Napier said they most of the U.K. domestic banks adding one last reason.

“Banks are less exposed than almost all sectors to the key 3Q earnings risk: supply chain disruption and inflation. And banks obviously provide gearing to an upside scenario in which the BoE hikes rates by as much as the curve implies,” he said.

Elsewhere, the FTSE 100 (FTSE:UK:UKX) traded flat at 7,208.01 on Tuesday, with the technology sector in the lead and utilities weaker. Gainers included Glasgow engineering group Weir and silver miner Fresnillo.

Shares of British Airways owner International Consolidated Airlines (LON:UK:IAG) , were down over 4% after a downgrade to ‘hold’ by Berenberg analysts, who cited concerns over heightened equity dilution risk. Wizz Air (LON:UK:WIZZ) was also cut to ‘hold’, owing to signs of a stretched valuation premium versus Ryanair . Those shares were down 2% and 1%, respectively.

Within the midcap FTSE 250 (FTSE:UK:MCX) , shares of Moneysupermarket Group (LON:UK:MONY) jumped 8%. The price-comparison website reported a 10% fall in third-quarter revenue, but said it still expects to meet Ebitda market expectations for the year.

Moneysupermarket also announced the acquisition of consumer cashback business Quidco for a price of up to GBP101 million ($138.7 million). That acquisition “adds a new string to the bow for the company and Moneysupermarket should be able to use its own considerable skills and expertise to accelerate growth,” said AJ Bell financial analyst Danni Hewson, in a note to clients.

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