Today's markets: Yields stable but damage is done

Bond yields are more settled this morning, having come down a touch last night after peaking early on Thursday, with the 10-year gilt yield hitting 4.93 per cent intraday. That yield is at 4.81 per cent this morning, still 20 basis points higher than a week ago, and still enough to have a real-world impact on government spending plans, mortgage rates and just generally how everyone ultimately feels about the state of the UK economy.

It seems traders are pricing in a worst-case scenario for the UK, of dismal to non-existent economic growth, rising inflation and the Bank of England caught in the middle, wanting to cut rates to help the economy but unable to do so due to rising prices. Worse is if Labour has to come back to the electorate or businesses and ask for more – to help fund rising borrowing costs – or cut government spending to ensure the chancellor’s own rules are met. The only thing right now that’s going to ignite economic growth is state-led reform or spending. Businesses are holding back given the uncertain economic outlook and rising business taxes, surveys have shown.

It’s not been an easy first six months for Labour, but you could argue it put itself into this mess. Everyone knew taxes had to rise, and no one blamed Labour for that. But by focusing on inflation-inducing business tax rises, rather than a balance of taxing workers and wealth too (it foolishly ruled out VAT, income tax and employee national insurance rises in its manifesto), it has tied its hands and perhaps the Bank of England’s too. Now only spending changes or U-turns can help, and Labour is hamstrung there too. Hard to see how we get out of this mess, and that’s exactly where bond traders are coming from. The one release valve is a weaker currency, which would make UK assets more attractive to overseas investors.

There’s more pain on the way too. Mortgage rates – which were supposed to fall this year in line with Bank Rate – have started creeping up and will continue to do so at this rate. There are still plenty of homeowners on pre-Liz Truss low borrowing deals coming up to remortgage time, and now their hike will be higher still. Then there’s the 300,000-so homeowners who took out two-year deals in the months after the mini-Budget, now coming to renew. Their costs will still go down, but not by as much as it could have, and that will suck some cash out of the economy.

The FTSE 100 has struggled this morning now that the pound is no longer falling notably against the dollar, dropping 0.2 per cent. The FTSE 250 is down 0.5 per cent, continuing its poor recent run, while shares in Paris and Frankfurt are marginally in the green.

Shares overnight in the US were effectively flat and there’s a bit of trepidation with the non-farm payrolls coming out later on. Panetheon Economics warns stock markets are “primed to overreact”, which is a fair comment given the general unease and what happened in response to the services PMI and job opening data earlier in the week.

Consensus is for a 165,000 increase in payrolls (which measures about 80 per cent of the US workforce), but surprises have become more common of late. Anything higher and we could see rate cut expectations fall back again, although traders have rounded on July as the first cut from the Federal Reserve this year, which is already very pessimistic.

By Taha Lokhandwala