It was a familiar cocktail of terror for the City this morning. A double-barrelled blast of Middle Eastern geopolitics and a transatlantic tech rout sent the FTSE 100 spiralling into its worst session since the Silicon Valley Bank collapse. Traders were left nursing their losses as the index shed 2.3 per cent by midday, wiping out nearly all gains since the August bounce.
The trigger? Reports of a coordinated drone and missile attack on Saudi Aramco’s Ras Tanura facility, the largest oil terminal on the planet. Brent crude surged past $94 a barrel, a threshold not seen since last October. The market’s immediate reaction was to flee to safety. Government bonds rallied, with the 10-year gilt yield falling 12 basis points to 3.88 per cent, as investors bet that the Bank of England would again be forced to choose between inflation and stability.
But the damage was not limited to energy stocks. The real bloodletting came from the tech sector. A reset of valuations in Silicon Valley, triggered by an underwhelming earnings report from a major AI firm, spread to London’s growth stocks. The FTSE 350 technology index fell 5.6 per cent, with Scottish Mortgage Investment Trust, a bellwether for growth and innovation, down 7.8 per cent. This has the feel of a market re-evaluating the risk premium it is willing to pay for future earnings in a world where capital is no longer cheap.
The Bank of England, ever vigilant, has put its emergency liquidity facilities on standby. While Governor Andrew Bailey has not yet spoken, sources indicate that the Bank is ready to step in if gilt market dysfunction worsens. This is a sobering reminder of the 2022 mini-budget crisis, when a collapse in gilt liquidity forced the Bank to intervene. The irony is not lost: a central bank designed to combat inflation is now poised to buy bonds to prevent a liquidity crisis even as inflation remains above target.
The currency markets are also flashing warning signals. Sterling fell 1.2 per cent against the dollar, trading below $1.24, as capital flight gathered pace. This is a classic sign of a loss of confidence. International investors, who have been net sellers of UK equities for six months, are now adding gilts to the sell list. The fear is that a sustained drop in the pound will import further inflationary pressure, making the Bank’s job even harder.
Fiscal responsibility, or the lack thereof, is now back in the spotlight. The Chancellor, facing a budget deficit that is still stubbornly high, will see the cost of government borrowing rise. The gilt market’s reaction to the past few hours suggests that the fiscal headroom built up by the previous administration has been squandered. The next government, whatever its colour, will have less room for tax cuts or spending increases.
As I write, the futures market is pricing in a 60 per cent chance of a Bank of England rate cut before Christmas. This is a dramatic reversal from the consensus just a month ago, which expected rates to remain on hold into 2025. The market is betting that the Bank will prioritise financial stability over inflation, at least in the short term. But this is a dangerous gamble. Inflation expectations, as measured by the 5-year swap rate, have already edged up, indicating that the market is starting to question the Bank’s inflation-fighting credentials.
In summary, the City is facing what I call a “liquidity double jeopardy”: a supply shock to energy markets and a demand shock to tech valuations, all while the central bank is caught between two masters. The Bank of England has the tools to intervene, but every action carries a cost. Today, the cost is credibility. The bottom line is that markets hate uncertainty, and right now, there is plenty of it.
