Recession risks spark UK market jitters ahead of BoE decision

UK markets are sounding the alarm over a potential recession, piling pressure on the Bank of England to balance curbing surging inflation with protecting growth.An index of discretionary retail stocks has tumbled 26% this year as consumer confidence slumps to the lowest since 2008, while nearly 2,000 businesses are in critical financial distress. The pound is trading at levels not seen since the early days of the pandemic, and money markets bet central bankers will have to cut rates in coming years after sharp hikes in 2022.It’s a “pretty ugly backdrop” to set the scene for the BoE’s meeting next week, according to BlueBay Asset Management’s Mark Dowding. Policy makers will have to take in a rash of bad news, with retail sales weaker than anticipated and inflation at a three-decade high.The central bank is widely expected to lift interest rates again Thursday and money markets expect more hikes at each meeting this year, piling further pain on borrowers. BoE Governor Andrew Bailey has already noted the difficult path bankers need to tread to avoid potentially triggering a recession.“The market is definitely of the view that the UK is more vulnerable here,” said James Lindley, a portfolio manager at BMO Global Asset Management. “If we didn’t have inflation, we would be thinking about cutting not raising interest rates.”Britain’s inflationary shock will be harder to address than in any other leading industrialised nation, the International Monetary Fund has warned. Here are charts showing how markets are dealing with the risks. Out of stock: Stocks most exposed to Britain’s domestic economy have underperformed year-to-date. The midcap FTSE 250 benchmark’s 12% drop compares with a 2% rise for the FTSE 100, whose firms earn three-quarters of their revenue abroad with high exposure to buoyant commodities prices.An index tracking discretionary retail stocks, including companies such as Marks & Spencer Group Plc and JD Sports Fashion Plc, is faring even worse, as price rises hit demand for non-essential goods. British consumers are being squeezed even harder than elsewhere due to a recent hike in the National Insurance tax and the removal of a cap on household energy prices, just as gas costs spike during the war in Ukraine.“We think that the UK is more vulnerable to an income shock,” said Frederique Carrier, head of investment strategy at RBC Wealth Management, adding that declining consumer confidence will likely feed into corporate results.Meanwhile, investors betting on the more global companies in the FTSE 100 – such as Shell Plc and AstraZeneca Plc – as a hedge against UK economic worries may be left disappointed.Price targets for the year ahead suggest the blue-chip index has among the lowest return potential of major international peers, according to data compiled by Bloomberg. The 12-month implied upside of 19% compares with 29% for the Euro Stoxx 50. Bears in control: The negative mood has led investors to flee the pound, down more than 4% to about $1.25 in April in its worst month since the aftermath of the Brexit referendum in 2016. Traders are favouring the dollar as a haven to global growth risks stemming from Covid-19 lockdowns in China as well as the energy standoff brewing between Europe and Russia.The slump may not be over yet, with analysts starting to talk of $1.20 and options traders lifting bets on further declines in coming months. The fear-greed indicator – a gauge of momentum that compares buying to selling strength – implies that bears haven’t controlled price action this much since the early days of the pandemic shock.For State Street Global Advisors portfolio manager Aaron Hurd, the long-term fair value for the pound comes in north of $1.50. But even he is reluctant to buy despite these cheaper levels, citing an absence of heavy short positioning in the currency that could pre-empt a reversal. “Now you have the recession risk and a more dovish Bank of England relative to more hawkish central banks outside of the UK – that’s a really toxic combination,” he said. These factors are also boosting bets on currency volatility, making it much more expensive to hedge.