The London Stock Exchange opened in a sombre mood this morning, the FTSE 100 slipping another 0.8% as traders priced in the grim prospect of a widening Middle East conflict. The benchmark index has now shed over 3% in the past week, its worst run since the mini-Budget chaos of 2022. This is not a panic, not yet. But it is a persistent, gnawing anxiety that has taken hold of the trading floors from Canary Wharf to the Square Mile.
The trigger, as ever, is oil. Brent crude surged past $90 a barrel overnight, a level that acts as a psychological tripwire for inflation-wary investors. The fear is that any further escalation, a direct confrontation between Iran and Israel say, could send prices towards $100 and beyond. For a Bank of England already wrestling with sticky services inflation, this is the last thing it needs. The market is now pricing out a rate cut in June, with the first full 25 basis point reduction not fully priced until November. That is a brutal reassessment from the optimism of January, when four cuts looked certain.
But the rot goes deeper. Gilt yields have crept higher, the 10-year now yielding 4.3%, reflecting both the oil shock and a creeping lack of confidence in UK fiscal credibility. This is the ghost of Trussonomics revived, albeit in a milder form. The Chancellor has limited headroom, and any additional borrowing to fund defence spending or energy subsidies would be met with a cold stare from the bond vigilantes. Capital flight is a word being whispered again, not on the scale of 2022, but as a quiet trickle out of emerging markets and into the dollar.
The irony is that the UK economy, with its services-heavy composition and North Sea oil, is less exposed than many. But in a globalised market, contagion is the name of the game. The VIX, Wall Street's fear gauge, is above 20, a level historically associated with heightened volatility. The algorithmic traders are now programmed to sell first and ask questions later.
What is to be done? The Bank of England can do little supply-side magic to lower oil prices. Its only tool is to keep rates high to anchor inflation expectations, but that risks cracking the housing market and consumer spending further. The government, for its part, must resist the siren call of fiscal stimulus. The era of handouts is over. Prudence, boring as it sounds, is the only path to maintaining investor confidence.
For now, the City holds its breath. The next few days will determine whether this is a correction or the beginning of something worse. The bottom line? Brace for more volatility. The era of cheap money and geopolitical calm is a distant memory.
