Sterling’s slump amid biting inflation: what this means for private investors

interactive investor comments on the impact of the mini-budget and the prospect of an emergency rate hike from the Bank of England.

The aftermath of the UK’s new government’s budget last week has caused a knee-jerk reaction from markets. Sterling has slumped, UK gilts continue to sell off, and yields are surging. Unsurprisingly, investors will be wondering what’s next, as a subsequent emergency rate hike from the Bank of England looks increasingly on the cards in a bid to bring inflation closer to target. 

interactive investor, the UK’s second-largest private investor platform, outlines the impact of this across various sectors, and explores what this means from an investment perspective. 

Giving the broader market overview, Victoria Scholar, Head of Investment, interactive investor, says: “Money markets are now pricing in an emergency rate hike with 175 basis points’ worth of increases by November after the pound hit a record low against the US dollar overnight.

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“The slump in sterling could exacerbate the UK’s inflation problem, with price levels currently flirting with double digits. More expensive imports may add to the UK’s upward price pressures, which is likely to prompt more aggressive action from central bank policy makers.

“The UK bond market is in turmoil with yields surging. The two-year gilt yield hit the highest level since the height of the financial crisis in 2008 while the 10-year yield hit the highest since April 2010.”

The plummeting pound’s impact on the bond market 

Sam Benstead, Deputy Collectives Editor, interactive investor, explains: "Bond investors are panicking, dumping UK government debt. Yields, which move inversely to price, have therefore shot up. The 10-year UK gilt now yields 4.1%, up from 3.5% before Kwasi Kwarteng’s budget.

"Nearly all UK bond maturities now yield more than 4%, pushing up the cost of issuing new debt for the government at a time when they are setting out to borrow on a huge scale to fund tax cuts.

"Bonds are selling off because investors expect the Bank of England to increase interest rates more rapidly to control inflation and boost the value of the pound. Financial markets now point to interest rates of 5.5% in the spring, up from 2.25% today, according to some economists.

"Rising interest rates is bad news for nearly all bonds, as investors re-price assets because they can get a higher yield from buying newly issued bonds. However, longer-term higher yields increase total returns for investors, and new investors get much more income from bonds today than a year ago."

The impact on pensions

Explaining the impact on pensions, Becky O’Connor, Head of Pensions and Savings, interactive investor, says: “Workplace pension funds are not as exposed as they once were to the fortunes of the UK economy. Now, you are as likely to find large US technology companies such as Apple (NASDAQ:AAPL) and Amazon.com Inc (NASDAQ:AMZN) in a default scheme as big British companies. 

“It is the ups and downs of the global, particularly US markets, that have a greater influence on our retirement pots. That may be reassuring given what is happening in the UK, but perhaps cold comfort given monetary tightening is still far from over in the US, as this could have a further dampening effect on equity markets. 

“That said, many British pensioners rely on the good health of some big UK-based companies for their retirement income. They would be concerned to see any signs that the current economic climate could start to effect dividend payouts.

“FTSE 100 blue chips with solid dividends and strong overseas earnings, are likely to continue to be held dear by the British public.”

Simple, easy-to-understand strategies with a focus on capital preservation

Dzmitry Lipski, Head of Funds Research, interactive investor, explains that many investors are going looking to simple, easy to understand strategies. 

He says: “We are moving ‘back to basics’ investing, and this could mean more challenging times for some esoteric, thematic, leveraged ETFs given their style biases towards fashionable themes. Simple, easy to understand strategies with a focus on capital protection rather than ‘shooting the lights out’ might be preferred by investors. Examples of these are Super-60 rated Capital Gearing (LSE:CGT) Trust, and Personal Assets (LSE:PNL) Trust. Those looking for a sustainable investment pick could look at ACE 40-rated Climate Assets Balanced Fund."

Adventurous long-term investors: which sectors could be set to benefit from the so-called mini budget? 

While sterling has been in turmoil against the dollar, Friday’s so-called mini-budget could prove a boost over the longer term, not least with corporation tax now remaining at 19%.

Dzmitry Lipski, Head of Funds Research at interactive investor, says the growth incentives could benefit small and mid-sized firms which have been underloved, if we see a stronger economy emerge from the mini-budget last week. 

Adventurous, contrarian long-term investors could look at a FTSE 250 tracker, such as the Vanguard FTSE 250 UCITS ETF (LSE:VMID). For investors looking for an actively managed fund, Henderson Smaller Companies (LSE:HSL) investment trust or theTB Amati UK Listed Smaller Companies fund are good options and both feature on ii’s Super-60 rated-list.