If, in the sweltering heat, it’s hard to imagine that it will be freezing cold in a few months, it’s just as hard to accept that economic conditions can change quite dramatically.
Intellectually we know that the heat and drought will end, although there are some difficult weeks ahead.
And we know that there will be a new UK government next month, which will put an end to the current political uncertainties – at least for a while. However, right now it’s all quite confusing and also worrying.
Light at the end of the tunnel?: It’s hard to accept that economic conditions can change dramatically
In my opinion, this is the best explanation for the relative calm on the financial markets at a time of great economic and political uncertainty at all levels.
Take the FTSE100 index. It closed at 7,501 on Friday, actually a catch-up on December 31, 2021 when it closed at 7,385.
That was when the latest CPI inflation figure for November was “only” 5.1 percent and of course the Russian invasion of Ukraine was eight weeks away. True, the pound is down significantly against the dollar as it ended the year at $1.35 and is now at $1.21.
But this is truly a safe haven dollar story, as the pound is virtually unchanged against the euro: €1.19 then and €1.18 now.
It’s the markets job to think six months or more ahead. So what they’re trying to say, in their inevitably incoherent way, is that many of the current uncertainties will be a thing of the past and that solid companies will make solid earnings and pay decent dividends.
It is implied that some sort of global recession will not be particularly severe and that inflation will be brought back under control without undue economic pain. That may or may not be true, but it’s the best way to explain why bleak economic forecasts, including the Bank of England stuff a decade ago, have been met with a yawn.
What’s next? There are several things worth watching. Next month there will be a spate of new economic initiatives in the UK once the next Prime Minister is installed and the Cabinet is in place.
My main hope is that the new government will focus on the longer term issues of UK competitiveness and manage its own operations more competently.
I also hope that she listens to business circles, large and small. But in the short term, just the fact that there is a change of face at the top will give the economy a boost. I still think it’s better that we can make ends meet this year without a recession.
The next thing to watch out for is the energy. Oil prices have been trending down since early June, and on Friday Brent crude was trading below $100 a barrel, just slightly above levels on the eve of the Russian invasion.
The oil market is on the verge of falling below $80 a barrel as the market appears to be moving from overdemand to oversupply as demand falls due to slower global growth.
Wholesale gas prices in Europe are staggering, four times higher than a year ago and double what they were in early June. That’s dragging UK prices up, so there’s no consolation there.
But think a year ahead. Either prices have come down significantly and/or Europe and the UK have found ways to use much less gas.
The justification for the relatively calm equity market response is that the gas shortage, while deeply troubling this winter, will be a temporary concern. Say it like this.
Rising energy prices won’t be pushing inflation higher in a year’s time, and falling costs are likely to pull inflation down.
Meanwhile, the world’s central banks, including our own, will continue to raise interest rates.
The faster inflation falls, the lower interest rate spikes, but everyone accepts that tightening monetary policy is an uncomfortable proposition and that the lags between a change in policy and an impact on prices are both uncertain and long.
Nonetheless, inflation is likely to peak this year in most developed countries, including the UK. Once the path leads down, everything becomes clearer. The markets can therefore anticipate the turning point in inflation in the coming months. This cautious optimism explains their relative calm. I hope and think they are right.
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