London calling!

The UK’s flagship index – the FTSE 100 – has risen recently even though the Conservative Party is about to elect a new leader and inflationary pressures continue to build up. Below, our analyst and fund manager, Christina Carlsten, takes stock of the situation for the UK economy both now and going forward.

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The cost of living – a hot topic in the leadership contest

On 5 September, the British people will know who’ll succeed Boris Johnson as Tory leader and prime minister. Liz Truss, the current foreign secretary, is the frontrunner – she’s well ahead of her rival, former chancellor of the exchequer Rishi Sunak. Both candidates have said they’ll cut taxes, but Truss’ policies are more aggressive than Sunak’s. And in the current climate, fiscal stimulus of any sort could fuel inflation. So what are the prospects for the UK economy and stock market?

Inflation – a conundrum for policymakers

Boris Johnson’s successor will have their work cut out: the UK economy is shrinking, and inflation has not yet peaked even though it’s already hit 10.1% year on year – its highest level in 40 years.

A tumultuous labour market

Sorting out the jobs market will be no mean feat either. Many sectors are experiencing labour shortages, more and more workers are going on strike to demand higher wages, and companies are having to offer sign-on bonuses to attract new employees. According to estimates from the Office for National Statistics, growth in average total pay was just above 5% from April to June 2022. Much of the increase in wages is a result of the UK economy opening up again after the pandemic.


Persistent inflation

It will be very hard for the Bank of England (BoE) to bring inflation back to its 2% target, especially if Liz Truss is elected. She intends to boost consumer spending by easing the cost-of-living crisis through deficit spending, but that will only push inflation higher and lead to more monetary policy tightening.

On top of that, commodity prices will continue to rise until supply and demand have evened out. And although the BoE began raising rates in late 2021 – several months before the US Federal Reserve and the European Central Bank – it is lagging behind in the pace of its tightening.

Could the UK economy enter a recession before the year is out?

The BoE has warned that the UK economy could enter a recession before the end of the year, since growth has already slowed sharply and the situation is unlikely to improve going forward.

Nevertheless, the FTSE 100 is one of the only indexes to have gained ground since the start of the year. There are several reasons for this: first, the pound’s continued weakness has been a boon for this internationally exposed index; and second, commodities, and particularly energy, which make up a significant proportion of the index, have risen 25% since the start of the year.

The story is quite different for small caps, which have lost 15% so far in 2022. Small caps have performed less well because they tend to be more exposed to the domestic economy, which is currently struggling.  

It’s therefore worth sticking to internationally oriented FTSE 100 stocks for the time being, since the pound is unlikely to rise sharply in the current climate.

Small caps will no doubt become more attractive once inflation has peaked and been brought under control by the BoE – and once the Tories have regained some credibility in steering the economy.


Are you interested in our analysis of economic and market news? Find our investment strategy for Q3 2022 here.

Want to know more about our philosophy and our investment solutions? Contact us and ask any questions you may have or visit our dedicated investment solutions page!





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