The headline Consumer Prices Index inflation rate in July fell to 6.8%, its lowest rate since March 2022. However, the stock market hasn’t reacted positively to the news and is trading sideways. So, here’s why, and what the outlook could spell for investors in the UK stock market.
The core problem
Inflation has haunted households and investors like a nightmare in 2022 and 2023. But some relief finally arrived as the latest data showed that inflation fell to 6.8% in July, matching analysts’ expectations. While still painfully high, the drop will be welcomed by many holding their breath.
Nonetheless, core inflation — which excludes the volatile food and energy elements — remains stuck at a stubborn 6.9%. This is in part thanks to rising costs for services like hotels, recreation, and dining out.
The sticky figure means the Bank of England may need to keep aggressively hiking interest rates to 6% or beyond. This may be why the FTSE 100 hasn’t popped, as the battle against inflation isn’t over yet.
With further rate hikes still possible, the recent drawdowns in mortgage rates could catch a break until the next piece of inflation-related data gets released next month. This means mortgage rates are unlikely to fall meaningfully until September at the earliest.
As such, those invested in housebuilders and financials, such as banks, could see their shares trade sideways for the next couple of weeks as the landscape surrounding mortgage demand and interest rates remains uncertain.
A pounding on earnings
Also, a perspective not being talked about enough is the impact of the strong pound (GBP) against other currencies. GBP tends to appreciate in value if markets expect the Bank of England to continue increasing rates — and today’s rise of the GBP against the USD is evidence of this.
Therefore, if core inflation remains sticky, it would appreciate the GBP. This isn’t good news because the bulk of FTSE 100 companies earn most of their profits in foreign currencies and would have to convert those profits back to GBP, resulting in lower earnings. This may be why the FTSE 100 remains stagnant.
Inflating returns over the long term
Having said that, those who opt to keep their powder dry and store their cash in savings accounts will benefit from higher deposit rates in the short term, as those invested in the FTSE 100 face ongoing risks.
After all, Britain’s premier index has delivered negative real returns over the past year as shares continue to struggle while inflation runs hot. So, until core prices cool, markets may remain muted and volatile. For now, safe havens like bonds may offer better short-term returns.
But for investors seeking bigger returns over the long term through capital growth and/or dividends, investing in the stock market still remains the best way to grow and compound wealth over the long term.
The inflation picture could very quickly change in the coming months. If signs of loosening emerge in the sticky services sector, rate hike fears may ease further. And with prices starting to crack in some sectors, July’s CPI print could be the beginning of the end of this inflationary nightmare.
