Mike Dolan: Britain bracing for brewing economic storm this winter

Britain's households are facing multiple hits from rising energy bills over the coming six months, deep real wage cuts, and rising borrowing costs

Liz Truss, the front-runner to be leader of the Conservative Party and the next UK prime minister, has promised some £30bn (€35.3bn) worth of largely unfunded tax cuts.

Fri, 19 Aug, 2022 - 14:08

Mike Dolan

If Britain's brewing economic storm looks like an outlier, UK markets have yet to reflect that fully — but investors may yet balk at the winter ahead.

Against the backdrop of a generally lousy year for most major markets and eye-popping inflation and recession forecasts, UK assets have held up better than you might think.

With the unenviable record of becoming the first G7 economy to see inflation top 10% amid the current global price spike, the Bank of England has already spooked everyone by forecasting a peak in the rate above 13% this autumn followed by the longest recession since the global financial crisis 14 years ago.

The country is still in a leadership hiatus and won't have a new prime minister until next month.

The favourite to take over, foreign minister Liz Truss, has promised some £30bn (€35.3bn) worth of largely unfunded tax cuts — but that just heaps more pressure on the Bank of England to double interest rates into next year to rein in inflation.

Multiple hits from rising household energy bills over the coming six months, deep real wage cuts, and rising borrowing costs all point to the lengthy freeze in demand the Bank of England is flagging following this summer of drought and political vacuum.

Winter of woe

"The path is set for a scorching summer of price rises to merge into a pretty awful autumn and a winter of woe as households struggle against this tide of inflation," Hargreaves Lansdown's Susannah Streeter said this week.

All sounds quite apocalyptic — and that's before you read the British press.

So presumably markets have seen this one coming? Well yes and no.

Sterling has lost more than 10% against a rampant dollar so far this year, UK government bond funds are down at least as much and domestically-facing UK midcap stocks are down almost 25% in dollar terms — underperforming even eurozone blue chips. And yet the picture is not a wholly exceptional one — not yet at least.

Flattered by the weaker pound and big weightings in UK-listed commodity and cyclical or value stocks like Big Oil, miners, and banks, the Ftse-100 index has actually outperformed many of its peers.

Sterling has felt the heat, but only marginally more than the euro.

Yet again, the big offset for many asset managers is the sectoral mix of UK equity indices and Ftse-100 in particular — heavy in neglected so-called value stocks such as banks that gain from higher interest rates and also commodity-rich oil and mining firms boosted by geopolitical shocks and supply-chain squeezes.

That's how Lombard Odier's chief investment officer Stephane Monier explains why his firm has retained its overweight in UK equities since early last year. But he thinks that may now change.

Post-Brexit economy

"At this stage I'm becoming more cautious on the UK. We are thinking about reducing that overweight to at least a neutral position," Mr Monier said, adding this was a long-term rethink about the direction of the economy post-Brexit and may well be executed in the coming weeks and months.

Beyond the relative ebbs and flows of inflation, growth and interest rates in the months ahead, Mr Monier said what unnerves him most is the lack of a coherent political plan to offset the losses to UK trade and competitiveness from leaving the EU.

"Regardless of the merits of Brexit, you have to make sure you have a really good plan to compensate for what you've lost from leaving the EU — and I fail to see that plan," he said.