FTSE 100 on course to end volatile week in the green as gilts suffer

UK stocks ended what has been a volatile week for UK assets firmly in positive territory. 

The FTSE 100 closed up 89.01 points at 7351.07 on Friday, while the FTSE 250 was up 1.6 per cent. The blue-chip index saw two consecutive negative sessions prior to today.

Sterling recovered to trade at $1.16 against the US dollar as the Bank of England said it would postpone its next interest rate decision until 22 September.

The pound has been under pressure this week as markets reacted the appointment of Liz Truss as Britain’s new Prime Minister, but it still looks to be on course to record broadly flat performance over five days.

10-year gilts have also had a better day, with yields falling from Thursday’s closing price of 3.162 per cent to 3.095 per cent by late afternoon.

However, gilts have sold off on average over the course of the week with the 10-year yield having traded at 2.91 per cent on Monday morning.

It followed an August that represented the worst month for 10-year gilts since 1986, with yields up 94 basis points, as markets adjusted to another jump in gas prices and expectations of increased fiscal spending.

Rising gilt yields will be of concern to Truss’ new government, which is planning sizeable spending in efforts to support households and businesses through the difficult winter ahead, as this means an increase in the cost of financing debt obligations.

Inflation hit 10.1 per cent last month and is forecast to go even higher, while the British economy is set to enter five consecutive quarters of contraction from the start of October, according to the Bank of England.

The Government will go ahead with an energy price guarantee plan to freeze the average British household’s gas and electricity bill at £2,500 for the next two years from 1 October.

This is set to cost the Treasury upwards of £100billion and suggestions that the Government will3 tax cuts will push borrowing even higher.

Chancellor of the Exchequer Kwasi Kwarteng told senior banking figures in the City earlier in the week that the Government’s plans will mean higher borrowing in the short term.

‘Due to the scale of the gas crisis, the Government’s first priority will be to support families and businesses in the immediate term,’ a statement said.

‘The Chancellor was clear this will mean necessary higher borrowing in the short-term whilst ensuring monetary stability and fiscal discipline over the medium term.’

The Bank of England’s Monetary Policy Committee will now meet later than planned to discuss next steps in its approach to controlling inflation.

Markets expect the bank to hike rates by another 50 basis points to 2.25 per cent, but some economists believe it will opt for a 75bps hike.

However, the potential for an Emergency Budget to be put forth before 22 September could give the MPC more to think about when it makes its decision.

Modupe Adegbembo, G7 economist at AXA Investment Managers, said: ‘The cap in energy prices takes 3 percentage points off our expected peak of inflation.

‘We now see inflation rising to 10.6 per cent in October compared to 13.6 per cent in January 2023 before.

‘The implications of the policy on public finances is not yet clear. Full costings are expected later this month in Chancellor Kwarteng’s fiscal event and will likely cost more than £130billion.

‘Assuming this were to be fully debt financed, this would add just under 5 per cent of GDP to the level of debt and likely resulting in deficits of around 5 per cent of GDP both this year and next, compared with March’s Office for Budget Responsibility forecasts of 4 per cent and 2 per cent.

‘Despite reducing the peak of inflation, we expect the MPC will need to go further to ensure inflation returns to target as the economy will unwind the assumed excess demand slower than would otherwise be the case.

‘On balance, we now expect the MPC to increase rates by 75bps [this month]…and pencil in 50bps hikes in November and December bringing rates to 3.5 per cent.’