Britain’s ‘Black Thursday’ Wasn’t About Anything Falling

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One of the financial world’s stranger quirks is its tendency to name its very, very bad days. 1929’s stock market crash was “Black Tuesday.” 1987’s was “Black Monday.” When the British pound crashed in 1992 as the country left the European Exchange Rate Mechanism, it was “Black Wednesday.” So you might expect that, given the British press has already named February 3, 2022 “Black Thursday,” UK stocks or the pound crashed. Yet Thursday, British stocks ticked down just -0.6% in sterling—hardly a move worth naming.^[i] The pound strengthened slightly against the dollar.^[ii] No, today earned its auspicious moniker not because of market reaction, but because of energy regulator Ofgem’s announcement that the energy price cap will rise 54% in April, the Bank of England’s (BoE’s) 0.25 percentage-point (ppt) rate hike, and the central bank’s forecast for the inflation rate to top 7% this spring. This, plus forthcoming tax increases, looks set to take a bite out of households’ real disposable incomes this year, creating political problems for embattled Prime Minister Boris Johnson and his potential rival, Chancellor of the Exchequer Rishi Sunak—and leading to some rather strange policy responses. Let us parse the day’s events and explore the potential market implications.

Our view on today’s rate move as a macroeconomic and stock market risk hasn’t changed since Tuesday’s commentary. Markets have largely priced the widely expected move already, and the UK’s yield curve doesn’t appear to be at risk of imminently inverting. But rate hikes do have some secondary effects, and those could add to some households’ woes.

About one-fourth of home mortgages in the UK have variable interest rates, which tend to rise and fall in sympathy with the Bank Rate.^[iii] A 0.25 ppt rate hike won’t break the bank for many these folks, if you will pardon the pun, but it will divert some extra cash to mortgage payments. This, at a time when homes on household energy providers’ default contracts will see the price cap for their annual bills rise by £693 to £1,971—and if you know anything about price caps, you know the cap tends to be more target than ceiling. Compounding matters, the National Insurance Contribution—the tax that funds the country’s National Health Service—rises in April, which The Telegraph estimates will cost each worker several hundred pounds annually.

Then too, prices are rising generally, with inflation outside energy running just over 4% y/y.^[iv] Wage growth, according to the latest BoE forecasts, likely won’t be enough to offset all the added expenses. We point this out not to spread gloom, but because we think it is important to look facts head on and acknowledge when all is not grand.

The government is also acknowledging this and, as governments are wont to do, is trying to help. No, it isn’t abolishing the energy price cap, which we continue to believe has not been a net benefit and likely makes prices higher than they would otherwise be, as it has driven suppliers out of business and killed competition.^[v] Instead, Sunak announced twin rebates. Households in the four lowest council tax bands (which is the UK’s local property tax) will receive a £150 council tax credit, which will affect a huge chunk of the country since the assessed property values are based on 30-year-old numbers. Additionally, all households will get a £200 energy bill rebate, but not until October—and “rebate” is a misnomer since households will have to pay it back over the next five years. Essentially, Sunak is betting that the energy price cap will fall a year from now so that households won’t notice a £40 annual rebate repayment charge. That is … not a sure thing. Needless to say, Sunak’s plans landed with a giant thud.

We see two general implications here—one economic and one political. On the economic front, we think it is fair to say UK consumer spending is probably not on the verge of a boom. Not with real disposable income poised to weaken and rising energy bills likely to sap demand for more discretionary purchases. We don’t think an outright economic contraction is likely, as higher energy bills still add to GDP.^[vi] But these rising costs do create winners and losers, and it wouldn’t surprise if retail sales and spending on goods and fun services in general were to drag a bit. The BoE already projects slower GDP growth this year, with its 2022 forecast down from 5% in November to 3.75% now. Reality may be weaker still. That isn’t bearish, in our view, but it does point to growth stocks beating value, as they typically do better in slower-growth environments—which in turn points to UK stocks likely lagging the world, as Britain’s markets tend to be more cyclical due to their heavy Energy, Materials and Financials weighting.

On the political front, Johnson is in trouble. The official report on the “Partygate” scandal, which came out this week, did not paint 10 Downing Street in a favorable light. Several high-ranking aides have since quit in apparent protest of Johnson’s actions, and more Conservative backbench Members of Parliament appear to be sharpening their knives. Today’s cost of living body slam likely makes things worse. Johnson’s attempts to pivot with industrial and climate plans aren’t winning over the masses, either. Meanwhile, Sunak—often named as a top contender in a leadership challenge—is seeing his own stock fall with household expenses and taxes going up, and today’s attempt to help people doesn’t appear to be helping matters. There are other potential challengers in the wings, including Foreign Secretary Liz Truss, but it isn’t clear the party overall has much appetite for a leadership change. Labour remains ahead in the polls, and while the next general election isn’t due until 2024, senior cabinet members have warned a successful leadership challenge would require a snap election so that the new PM could get a mandate from voters. After all, former PM Gordon Brown’s failure to do so in 2007 after taking the reins from Tony Blair is widely pinpointed as the start of his downfall with voters. With little indication that the Tories would be able to win a general election right now, given none of the leadership contenders have personal popularity rivaling Johnson’s in 2019, the status quo could very well stick.

The upshot in that scenario would likely be a very gridlocked government. That will annoy those who were hoping for a big post-Brexit deregulatory push, but it will also prevent radical legislation in general, which is typically a tailwind for stocks. A government that can’t pass much can’t create many winners and losers, reducing uncertainty. While the UK’s value bent and likely slow growth should keep it from leading, the current political uncertainty dissolving into gridlock over the next few months should at least keep British markets climbing, in our view.

As for the other possibilities? A successful leadership challenge without a snap election would probably also yield gridlock, as the party wouldn’t want to rock the boat ahead of 2024’s contest. And if there is a snap vote, well, best to cross that bridge if and when it arrives when considering politics’ market impact. Simply having a contest would raise short-term uncertainty, but the longer-term impact would depend on how strong a mandate the winner secures, how campaign proposals have affected sentiment, and how reality looks poised to square with expectations. For now, it is far, far too early to sketch all of this out. So, patience—but we will be watching closely for you.