With the new UK prime minister just days away from taking office, markets are sending a message of trepidation at what happens next.
The pound has tumbled to $1.15 and trading near the lowest since 1985. The FTSE 100 Index shed more than 3% this week. Borrowing costs for blue-chip British companies now exceeds 5% and homeowners are grappling with sharply higher refinancing rates.
Some of the moves are being driven by a global bear market and broad shift away from risk, but the mood among investors about the UK and its path forward is especially bleak. Liz Truss, currently foreign secretary, is the front runner in the race against Rishi Sunak, and many investors have criticized her policy of tax cuts as fuel to stoke the inflation fire.
“Her policies so far are making UK assets more generally less and less investible,” said Max Castle, a fixed income portfolio manager at Mediolanum International Funds Ltd.
He rattled off a long list of reasons: the impending recession, the weak pound, faster inflation and a hawkish Bank of England, adding that “these are all very negative for the UK and make allocating towards UK assets very difficult.”
The next prime minister will form a government during a hostile period in the country: workers are staging nationwide strikes for better pay and families are wondering how to keep the heat on in their homes this winter.
Market strategists, such as Susannah Streeter at Hargreaves Lansdown, say there’s an additional risk that Truss’s policies will add to the UK’s debt burden and not go far enough to fix the flagging economy. Truss has been opposed to a further windfall tax on extraordinary profits linked to high gas prices, and ruled out rationing energy this winter.
“The worry is that far from pulling the economy out of recession, her policies risk a prolonged period of stagflation,” said Streeter, senior investment and markets analysis at Hargreaves Lansdown.
Others point to uncertainty over Truss’s positions on the Northern Ireland Protocol and whether she would sow further discord with the European Union. During the campaign, Truss also suggested changing the BOE’s mandate if she wins power.
Truss has been thin on details so far, and traders are bracing for more erratic market movements. One-month implied volatility on the pound is now the highest since mid-July.
“We’re going to see a lot of volatility and uncertainty in the first few weeks as the new cabinet emerges and the policy platform is laid out, and sterling is not going to like it,” said Dean Turner, economist at UBS Global Wealth Management. “The risks are skewed more towards a negative surprise than a positive.”
What matters is whether the proposed policies actually take shape or turn out to be just tough talk on the campaign trail, according Adam Cole, head of FX strategy at RBC Europe. Once there’s a clearer picture on what the prime minster plans to do, investors will know whether to buy or sell the pound, he said.
“Markets are taking the campaigning with a pinch of salt,” he said. “There’s an implicit assumption that when we get the policy changes, they will be in a watered down format.”
-With assistance from Kat Van Hoof.
This article was provided by Bloomberg News.