The FTSE 100 rallied 1.8% on Wednesday and the FTSE 250 recorded its best day since February, as UK inflation came down to 7.9%. So with things moving in the right direction, is a bull market on the way?
It’s good for the UK to see inflation easing, but I think there are still some big challenges ahead. As a result, I’m treating the latest news with caution.
An improved outlook
Before this week’s announcement, inflation was proving hard to bring down from 8.7%. But this was causing two types of problem for individuals and businesses.
For individuals, higher prices were putting household budgets under more and more stress. And for businesses, higher costs were putting pressure on margins.
As a result, the Bank of England raised interest rates aggressively from 4.5% to 5%. But this surprising increase sent share prices lower as investors feared the possibility of even higher rates.
On the face of it, though, it seems the big increase has got inflation coming down again. And this could be a double boost for the UK stock market as the problems of high inflation and rising rates subside.
Falling inflation should help decrease prices for both customers and businesses. And the prospect of interest rates peaking at 5.75%, rather than above 7%, should provide something of a tailwind for stocks.
Reasons for caution
Inflation coming down is clearly a good thing, but despite the positives, I think there are still reasons to proceed with caution. The biggest of these is the rate at which wages are growing.
On average, wages increased by around 7% between March and May. Higher salaries are a positive thing for various reasons, but inflation isn’t one.
Prices rise when there’s too much money chasing too little in the way of goods and services. So higher wages meaning more money in consumer pockets doesn’t help correct this imbalance.
There’s also an issue with the price of housing – an important contributor to inflation. A structural undersupply of housing is likely to limit the extent to which prices come down in the property sector.
Lastly, there’s the possibility of the UK government putting pressure on companies to lower prices, especially in food and energy. While this might be welcome for customers, it’s unlikely to help businesses.
Time for a bull market?
In my view, it’s not obvious a bull market is imminent. But that might be a good thing for investors like me.
The path to 2% inflation looks challenging to me. And I’m not at all clear interest rate increases can remove all the obstacles.
In general, though, I see it as a good thing when there’s pessimism in the stock market. Lower share prices make me more optimistic for buying opportunities in UK stocks.
I’m therefore seeing the recent rally as something of a short-term phenomenon. And I’m continuing to look for opportunities to buy UK shares when they trade at bargain prices.
