Market report: Footsie falls as energy prices and borrowing costs rise

FTSE 100 trades in the red amid fresh fractures in the Middle East.
Brent crude jumped to around $114 a barrel before easing back slightly.
UK 10-year gilt yields spike again – reaching 5.05% as political uncertainty and interest rate hike fears swirl.
Higher gilt yields constrain UK spending plans and add unpredictability to the mortgage market, with housebuilders among the fallers in early trade.
The Brexit effect is still holding back trade and growth according to the Federation of Small Businesses.
Vodafone to pay CK Hutchison £4.3 billion to buy its share in joint venture VodafoneThree.
Susannah Streeter, chief investment strategist, Wealth Club

“The reignition of hostilities in the Middle East has fired up oil prices again, keeping investors on edge about the duration of the conflict. London’s FTSE 100 is in a downbeat mood, as wariness rises about how difficult the complex situation will be to resolve. Investors are also on edge as fears of interest rate hikes rise, and there’s fresh political uncertainty in the mix ahead of key local elections on Thursday.

The Middle East situation is dominating, with the ceasefire looking increasingly fragile after an Iranian drone strike on the UAE’s Fujairah oil facility and reports that two US ships entering the Strait of Hormuz were also attacked. Brent crude shot up to trade around $114 a barrel before easing slightly, as hopes for a significant resumption of oil shipments from the region are being dashed again. The fresh fracture in the region comes following President Trump’s ‘freedom’ plan aimed at restoring shipping through the Strait of Hormuz.

Shipowners and their insurers are set to stay super-cautious about vessels using the key waterway, given the risks of mines, small boat strikes, and potential drone attacks. However, the longer prices at the pumps stay elevated, hitting the wallets of millions of Americans amid looming mid-term elections, the more pressure will build on President Trump to find a resolution. But it’s clear Iran is preparing to play hardball in negotiations, given its clear leverage over the Strait of Hormuz.

UK gilt yields have edged even higher as painful energy prices and the tense Middle East situation mean multiple interest rate hikes look likely. There’s also unease ahead of the local elections, with Labour expected to take a drubbing in the polls. This could potentially weaken Keir Starmer’s position further, and investors in UK government debt are uneasy, given worries that a replacement might cause the government to veer into a less fiscally responsible spending direction. The 10-year gilt yield rose above 5.05% briefly, a level it hit earlier in March, but it hasn’t been seen since the Global Financial Crisis that yields hovered around this level, above 5%.

Rising gilt yields mean it’s becoming more expensive for the government to finance UK debt, which puts pressure on current budgets. At a time when calls are growing for extra support for cash-strapped households and businesses, higher borrowing costs mean the Treasury’s room for manoeuvre is shrinking, with more revenue being absorbed by debt interest payments. This may force increasingly difficult choices – higher taxes or tighter public spending elsewhere. The burden of higher taxes on businesses has already been blamed for reluctance among employers to take on younger staff. If borrowing costs remain elevated, it also reduces the likelihood of tax cuts that might otherwise have helped support growth and the labour market.

Rising yields also act as a red flag for the mortgage market, given that banks and lenders price many loans off these market moves. Fixed-rate mortgages are closely linked with swap rates, which in turn tend to move closely with gilt yields. As yields have risen, some of the cheaper deals have been pulled, and lenders are likely to remain cautious about the path ahead. Shares in housebuilders have been on the back foot in early trade, as investors assess what the repercussions could be for the housing market.

Gilt yields are also used to price other forms of borrowing, meaning they can make the cost of major investment projects significantly more expensive. This can lead companies to mothball large-scale plans, with knock-on effects across supply chains as spending is curtailed, growth stalls, and job prospects are dented.

There are fewer levers to pull to find trading opportunities elsewhere, given the UK’s constrained trading situation with the EU. The long shadow of Brexit is keeping small businesses out in the cold when it comes to trade with Europe. The Federation of Small Businesses has highlighted the corrosive effects of complex rules, red tape, and rising costs for firms trying to trade with the continent.

The vote to leave the EU, and the way it was implemented, is still acting as a significant drag on growth. Small and medium-sized businesses are seen as the engines of job creation, and their export efforts are constrained by complex regulations. Resetting the relationship with the UK’s closest trading partners is crucial, and this evidence should help the government in justifying its drive to align with European standards and new laws without having to return to Parliament for permission at every turn.

And Vodafone is taking full control of VodafoneThree, in yet another consolidation in the UK’s telecoms market. While it will cost £4.3 billion to buy CK Hutchison out of its share of the venture, it has been cautiously welcomed by investors, who appear to appreciate that it will enable Vodafone to have a tighter grip on strategy, cut costs, and potentially lay the groundwork for swifter execution of its plans.

Given that joint ventures can slow decision-making, this should enable Vodafone to up the pace of its 5G infrastructure roll-out, improve network quality so it can compete on performance and reliability. It may also help with cross-selling its broadband offering, with bundled digital services seen as a cash cow given they generate recurring revenue, often at higher margins.”