Asset Intelligence Comment: Volatility in UK financial markets
By Kel Nwanuforo
The economic and market headlines have been gloomy for some months now. However, ever since Chancellor Kwasi Kwarteng delivered his ‘Growth Plan Statement’ last week things have turned downright downbeat.
Followers of finance woke on Monday morning to find that over the weekend, trading in markets overseas had pushed the value of Sterling to its lowest-ever level against the US dollar ever – just above $1.03. For context, at the start of this year a pound bought you just under $1.35. And less than fifteen years ago – well, every pound was worth $2.00.
This really is quite the milestone and the scale and speed of the recent decline has been truly striking. Indeed, it would be fair to say that the Chancellor’s financial statement was the worst-received in living memory. So why are global traders and investors selling the pound?
The key concern is that tax cuts will put more money into our pockets and companies’ bank accounts, adding to overall demand within the economy at a time when the supply of goods and energy is already tight. Traders therefore reason that this will drive inflation even higher than it already is. High inflation within an economy tends to be seen as a reason for the currency’s value to erode. That makes sense – because each year that inflation remains high in the UK, you are able to buy less and less with each pound.
What effect does this have on all of us; why does it matter? First off, the pound’s reduced buying power means that it will now cost more for us to buy imported goods, food, energy and raw materials. For a country already grappling with high inflation, this is obviously less than ideal.
What else? When global investors lose confidence that a country’s currency will retain its value over the medium-term, they tend to demand a higher interest rate to compensate. Unfortunately we have also seen this effect at work big time in recent days. In the wake of Mr Kwarteng’s statement, the cost of government borrowing jumped by one of the biggest one-day increases on record.
This matters for everyone. The cost of government borrowing is closely linked to rates on mortgages as well as all other consumer and business credit. We have already seen mortgage rates rise and some lenders have withdrawn home loan products given the recent volatility.
So the UK is clearly in something of a tricky spot. It is likely that the Bank of England will now have to start moving more aggressively in raising rates to try and persuade international investors to hold Sterling once again. That is what happened after two of Mr Kwarteng’s forebears, Anthony Barber and Nigel Lawson, slashed taxes. Of course, this too would hurt the economy in the short-term. But it is probably now unavoidable after a period in which America has been much more forceful in raising rates than we have been.
Finally – what does all this mean for UK-based investors?
It is worth keeping in mind that nowadays, most portfolios managed by professionals invest on a worldwide basis. Further, the UK only makes up around four per cent of each of the key global stock and bond indices by value. US securities denominated in dollars dominate both asset classes.
It is also worth bearing in mind that many UK companies, particularly larger ones, do much of their business overseas. This means they generate revenues in currencies other than Sterling. British firms could also benefit from improved competitiveness in export markets and are likely to attract takeover interest from firms overseas looking to pick up bargains.
One final thought. A Conservative government in its fourth term struggles to defend the value of the pound as traders lose confidence in economic policy. No, not current events – but Black Wednesday, thirty years ago almost to the week.
History may not repeat but it certainly does rhyme.