Amid rising inflation and the current cost of living crisis, the outlook for the UK economy is now considered ‘weak’. So, with the UK facing a shaky future, why hasn’t the FTSE 100 crashed? Let’s take a look.
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What has happened to the UK economy recently?
Back in 2020, the Covid-19 pandemic caused the UK economy to suffer its worse recession in over 100 years. The UK’s Gross Domestic Product (GDP) plunged by almost 20% between March and June 2020. While the economy mounted a mini-recovery, overall, UK GDP had fallen a colossal 9.4% by the end of the year.
The UK economy improved significantly the following year. However, UK GDP was still officially below its pre-pandemic level during the final quarter of 2021.
The Office for National Statistics will release updated GDP figures for the first quarter of 2022 on 31 March.
What’s the outlook for the UK economy right now?
According to Dhaval Joshi, chief strategist at BCA Research, the UK economy is looking frail right now. He explains: “The outlook for the UK economy is weak at the moment because of the triple whammy of higher taxes, interest rates and energy prices. That is going to squeeze consumer spending in the next couple of quarters or so.”
Let’s take a look at each of these factors in more detail.
Increased tax burden
We know the tax burden is set to increase for millions of workers from 6 April when National Insurance (NI) rises by 1.25%. However, this blow will be cushioned for some following the chancellor’s recent decision to increase NI thresholds from July.
Despite this change, many workers will still face paying higher contributions in the future.
Interest rate rises
The UK inflation rate now stands at a 30-year high. This is partly due to disruption to global supply chains, which is contributing to higher commodity prices. Importantly, high inflation puts pressure on the Bank of England to raise interest rates.
When interest rates do rise, it increases the cost of borrowing. This can be a problem, especially if you have a lot of debt that is in any way linked to the base rate.
Higher interest rates aren’t just bad news for debt-laden consumers though. That’s because the UK government is running a £318 billion budget deficit right now – equivalent to 95% of UK GDP.
Of course, this debt will need to be repaid, and some of the interest payable will be linked to the Bank of England’s base rate.
It’s worth knowing that a large part of the government’s budget deficit can be attributed to its spending policies throughout the Covid-19 pandemic, including a ‘bounce back loans scheme.’ The scheme has since come under fire due to a suggestion that £16 billion has likely been lost to fraudsters.
Higher energy prices
The energy price cap will increase from 1 April. This will raise the average energy bill to £693 per year and is expected to impact 22 million customers.
Ofgem says the increase is driven by a “record rise in global gas prices over the last six months”. The energy regulator also says that wholesale energy prices have quadrupled in the past year.
Similar to the impact of interest rate rises and April’s tax hike, higher energy costs can significantly impact the disposable incomes of consumers. As a result, next month’s rises are likely to place further pressure on the performance of the UK economy.
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Why hasn’t the FTSE 100 crashed amid the bleak economic outlook?
The FTSE 100 is now 0.5% lower than at the start of the year. So, while the UK’s blue-chip index has dropped since 2022 began, it hasn’t fallen significantly.
BCA Research’s Dhaval Joshi explains why this is the case. He says: “There is very little connection between the UK stock market and the economy. The FTSE 100 is a collection of international stocks steered towards commodities and financials.”
So, in other words, it’s a mistake to come to the conclusion that the stock market is closely linked to the performance of the UK economy. The FTSE 100 is commodity-heavy, and we know that commodities such as oil have performed well in 2022.
Higher oil prices can, of course, contribute to the rising cost of living. So, while oil stocks have soared this year, higher oil prices aren’t particularly good news for the wider UK economy.
On a similar note, it’s worth bearing in mind that while FTSE 100 stocks are listed on the London Stock Exchange, many of its members have significant interests outside of the UK. This is another reason why the FTSE 100 hasn’t suffered badly in 2022 despite the UK economy’s bleak outlook
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The post If the outlook for the UK economy is ‘weak’, why hasn’t the FTSE crashed? appeared first on The Motley Fool UK.
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