Rising inflation, bond yields and Middle East tensions unsettle investors
Susannah Streeter, chief investment strategist, Wealth Club: “A febrile environment is developing on equity markets as an increasingly entrenched Middle East crisis stokes fears of inflation reigniting, sending downbeat sentiment rippling across global markets. We’ve seen sharp sell-offs in Asia, with the Nikkei down 3% and South Korea’s Kospi falling 5.8%, as tech stocks are hit hard by concerns about interest rate hikes. The tech-lite nature of the FTSE is keeping it more insulated from turbulence, with the index flat at the open, but the global nature of the index means it isn’t completely immune when optimism evaporates, especially with inflationary concerns moving front and centre in the UK.
The jagged line of price increases has taken another painful twist upwards, with households facing a fresh squeeze as higher energy bills push inflation further away from the Bank of England’s target.
Consumer Prices Index inflation climbed, unhelpfully, to 2.9% in July from 2.6% in June, as the 13% increase in Ofgem’s energy price cap fed through into household bills. The average annual dual-fuel bill has risen by £221 to £1,862, with gas prices particularly responsible for the upward pressure.
For households, this is a particularly unwelcome page turn in the inflation story. And the financial pain may be sharper because private-sector regular pay growth has slowed to 2.8%, so wages are now rising more slowly than prices overall. Workers are therefore having to stretch their pay packets further simply to stand still, with less left over after covering essential bills.
There are, however, some welcome signs of easing elsewhere in the inflation basket. Petrol prices fell by 3.1 pence a litre in July, while diesel dropped by 8.8 pence, helping to pull annual motor fuel inflation down to 15.5% from 21.3%.
There was also some relief for holidaymakers, with European air fares helping to push transport inflation lower. It appears the flash of uncertainty caused by the war with Iran and concerns about jet fuel shortages prompted more holidaymakers to book later, intensifying competition between airlines and pulling down the price of some tickets.
Price rises for food and non-alcoholic beverages also appear to have been going in the right direction, with inflation easing to 1.3% from 1.7%, its lowest rate since September 2021. But it could be the lull before the storm, given worries are intensifying that prolonged heat and drought across the UK and Europe are threatening crop yields, with concerns over supplies of cereals, fruit and vegetables. If shortages build, higher agricultural costs could eventually feed through to supermarket shelves, putting renewed pressure on food prices later this year and into 2027.
So the headline rate may be concerning, and there are niggles of worry about what could be ahead, but if you strip out volatile food and fuel prices, then the core rate of inflation has held steady at 2.6%. This will be more reassuring for the Bank of England, especially with services inflation easing from 3.6% to 3.4%. Policymakers will also have an eye on the cooling labour market, with vacancies falling and public-sector pay increases easing. Right now, two interest rate hikes are still priced in by financial markets, but forecasts have changed wildly, and much will depend on the data in the months to come.
But the Iran crisis remains a huge wildcard, and right now the heat is still being felt in energy markets, with Brent crude hovering close to $92 a barrel with hostilities continuing and negotiations for a long-term solution remaining elusive. If tensions keep oil and gas prices elevated for months rather than weeks, higher energy and transport costs could start to feed through into the wider economy, potentially triggering renewed wage demands.
At the same time, a pressure cooker is building in bond markets, with yields becoming increasingly steamy amid concerns about persistent inflation, heavy government borrowing and the sheer scale of debt being issued. Global long-term bond yields have climbed to multi-year highs, adding to the sense that investors are demanding more compensation for taking on the risk of holding government debt.
That is creating turbulence for equities because higher yields make bonds more attractive relative to shares, while also raising borrowing costs and reducing the present value of future corporate profits. The effect is particularly uncomfortable for highly valued technology stocks, where valuations are highly reliant on expectations for future earnings. That’s why turbulence continues to hit the tech sector, with South Korea’s chip stars particularly affected as optimism seeps away, with SK Hynix and Samsung again seeing sharp falls.”