Susannah Streeter, chief investment strategist, Wealth Club: “The upsurge in fighting in the Middle East has caused fresh jitters across global markets. Japan’s Nikkei plunged more than 4%, and the uneasiness has spread into Europe. London’s FTSE 100 has opened lower as fresh worries about tense geopolitics and higher energy prices collide with the uncertainty surrounding the new Burnham administration, and what future policy direction will mean for the UK economy.
Brent crude has set off on a hot streak, trading around $90 a barrel as military action has intensified between the US and Iran. That’s an increase of 30% from lows seen earlier in the month. Already the latest attacks have expanded beyond military targets, with bridges, utilities, and port facilities coming under attack, and the countdown is on to an even wider escalation, given that President Trump has vowed to increase attacks on Iranian infrastructure on Wednesday. This could trigger further retaliation, ensnaring the region in an even more complex situation. Iran has called on Houthi rebels to close the Bab el-Mandeb strait on the Red Sea oil route if the US carries out its threat. The conflict appears to be becoming more fractious by the day, and with Iranian forces launching fresh attacks on what it considers to be US allies across the region, restoring longer-term stability looks to be an ambition increasingly out of reach.
Markets are still clinging to the hope that political pressure could eventually push President Trump towards a deal. Operation Epic Fury has become increasingly unpopular at home, and with the midterm elections on the horizon, there are expectations that the White House will look for an exit ramp. But Trump has built much of his leadership around projecting strength, and with Iran using the Strait of Hormuz as leverage, any sign of retreat risks looking like weakness. For now, that may make a negotiated settlement harder to achieve.
Research just out from EY-Parthenon shows that profit alerts in the UK from travel and leisure firms have hit their highest level for nearly four years, amid the fallout from the Iran conflict. Once again, travel firms and housebuilders have sold off today as the escalation in the war looks set to dent their prospects. Airlines have flown lower in early trade, amid worries about bigger fuel bills and fresh disruption to key routes around the Middle East. Travellers have already shown more reluctance to book early, given the uncertainty surrounding the repercussions of the conflict on budgets and travel plans.
Ryanair's results show just how quickly nervousness surrounding the war has seeped into booking patterns and operational costs. Its profit has slumped by a third due to higher fuel costs and the reticence of passengers to book holidays as war rages in the Middle East and cost-of-living pressures mount across Europe. It's a sign that consumers are once again tightening their belts and delaying discretionary spending, leaving airlines exposed not just to soaring jet fuel costs but also the prospect of softer demand. If the conflict drags on through the peak summer season, pressure on earnings across the travel sector looks set to intensify.
Housebuilders are in the red, as investors brace for higher interest rates, with energy prices set to ramp up again. There had been hopes that the recent spike in energy prices would continue to be blunted. Wednesday's CPI figures are expected to show inflation easing slightly from May's 2.8% annual rate. But any relief may prove short-lived given this escalation in the Middle East, which is likely to feed through into fuel, transport and business costs over the coming months. With the respite from higher inflation looking increasingly fleeting, interest rate expectations have shifted again, with at least two rate hikes now being priced in by financial markets. This will have yet another effect on affordability and is likely to keep more buyers on the sidelines. With housebuilders facing fewer reservations and the prospect of higher costs on construction sites, it's not surprising shareholders have become increasingly uneasy.
With living costs looking set to rise again, it's piling yet more demands onto Andy Burnham's towering in-tray. He's already promised a breathing space for households from painful increases in everyday bills, but it's far from clear where the funding will come from. Government borrowing costs have shifted higher again due to rising inflationary concerns and expectations of further interest rate increases. But there is also wariness on bond markets about the future path of government policy as Burnham prepares to unveil his top team. Current Home Secretary Shabana Mahmood, the frontrunner to be Chancellor, is considered to be a relatively safe pair of hands given her previous role as shadow chief secretary to the Treasury. However, there are still significant concerns swirling about the impact of an increase in capital gains tax, which she is believed to support, given that it risks quashing the entrepreneurial spirit the UK needs to harness to boost growth.
But eyes will be on other key Cabinet roles too, particularly who will lead the Ministry of Defence, given the challenge ahead for the UK's armed forces in dealing with heightened threats on a more limited budget than required to meet the demands of the Strategic Defence Review.
The future of Thames Water is also looming over the new administration, threatening to become one of its first major economic tests. It's rapidly becoming a measure of how Andy Burnham intends to balance protecting taxpayers, reassuring investors and delivering on promises to clean up Britain's waterways.
A consortium representing around 100 institutional investors holding £17 billion of Thames Water's debt has offered to write off almost half of what it's owed and inject more than £3 billion of fresh capital. On paper it looks like a significant concession, but the creditors want something in return, and that’s greater protection from future pollution penalties to improve the company's long-term finances.
That's set to prove highly challenging given that river and sea pollution has become one of the most toxic issues in British politics. Environment Secretary Emma Reynolds is understood to be deeply sceptical that easing the regulatory burden is an acceptable price to pay. From the government's perspective there's little appetite to be seen rewarding the very investors who helped finance years of under-investment, particularly when households are still facing rising bills.
This is fast becoming a test case for how the new government intends to treat private capital in regulated industries. If ministers are seen to take too hard a line, future investors may think twice before financing Britain's ageing infrastructure. But strike too generous a deal and the government risks accusations that taxpayers are once again underwriting the consequences of private sector failure. It's a balancing act which could shape confidence in UK infrastructure investment well beyond the water sector.”
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