Rising expectations that consumer price index (CPI) inflation will fall to 2 per cent in April, following better-than-expected figures from the Office for National Statistics (ONS) for January, nudged open the door to an interest rate cut from the Bank of England (BoE) by early summer. This was forcibly ajar following the news the economy shrank by 0.3 per cent in the final quarter of 2023, putting the country in a technical recession.
On top of this, inflation was unchanged at 4 per cent last month against a consensus view that it would rise to 4.1 per cent, and core inflation was also unchanged at 5.1 per cent. Although services inflation rose 10 basis points on December’s level to 6.5 per cent, it came in below the consensus forecast of 6.8 per cent. It’s possible that CPI inflation will drop to 3.5 per cent this month, says Paul Dales at Capital Economics, while Kallum Pickering at Berenberg says that short of another major supply shock to prices, the inflation numbers keep the BoE on track for five cuts this year, starting in June.
This is cheerier stuff – earlier data on wage growth that came in higher than expected at 5.8 per cent, well above inflation, had dampened the market’s expectations on rate cuts.
Being able to throw off the oppressive weight of soaring inflation and high interest rates will help reshape prospects for listed companies. These aren’t the only negative forces being exerted on the market of course. There’s the ongoing gravitational pull of the US stock market too and Britain's lack of technology companies. Despite a sharp but short jolt to the US market this week on higher-than-expected inflation numbers, it has been quite the party in New York since the start of the year. Big Tech’s Q4 earnings reports have been dominated by talk of glowing AI-powered futures, while Microsoft's earnings beat and Meta’s decision to pay dividends have made investors positively drool over the Magnificent Seven all over again. Meta’s market cap soared by more than $190bn in a single day on the back of its results.
Even investors who heed Sir John Templeton’s adage that the four most dangerous words in investing are “it’s different this time” may be soothed by the abundance of analysts – for now – arguing that far from being too highly valued, there is still room for multiple expansion among the Magnificent Seven. But the higher these stocks rise, the more important it is for investors to properly diversify, something that could deliver support for British stocks suffering from cooled investor interest.
At least any propensity by US companies to look more favourably on paying dividends will not constitute a new encroachment on the UK stock market. Dividends are London’s hallmark but yields here are considerably higher. In any case, for British investors, any US dividend-icing will be slightly less sweet given the complications of currency charges and taxation.
Of all the factors that will help restore some equilibrium to London, a more favourable economic backdrop is therefore the first. Inflation returning to target, interest rate cuts, and an economy in growth mode would all be helpful. The technical recession, at least it should be, in Andrew Bailey's words, shallow and short-lived.
A second factor would be a successful flotation or two. An IPO that doesn’t badly underperform will change expectations after many disappointments.
Third, government support in the form of measures and incentives to reinvigorate markets is needed. Many are already under way. The Quoted Companies Alliance has proposed several fast fixes to the Treasury it believes should be included in the Budget. It would like the restoration of the Pep-era rule that 50 per cent of investments within the Isa shelter should be invested in UK stocks. The QCA also argues that stamp duty should be scrapped on share trading for companies outside the FTSE 100 and for the establishment of a UK Growth Trust to provide vital scale-up funding for companies that fail to or no longer qualify for EIS and VCT support.
When I wrote about why I believe a British Isa is a good idea ('The compelling case for a British Isa') some IC readers were appalled at the idea that they would be ‘forced to buy British’. But they wouldn’t, any more than they are forced to limit their investing to £20k a year.
You could still buy all the overseas shares you wanted, although I admit that the reduction in the capital gains allowance from £12,500 to £3,000 isn’t helpful in this regard. So while my firmly held view is that there really is nothing wrong with the idea of taxpayer-funded breaks being at least partly used and I stress partly to support British businesses, the best solution of all would be a significant increase in the individual savings acount (Isa) allowance.
