The London stock market suffered its biggest slump in two months after the price of crude oil raced back above $100 a barrel yesterday, triggering fresh inflation fears across global financial markets.
The FTSE 100 index fell 1.3 per cent, or 141.6 points, to close at 10,670.06. The drop marked the blue-chip index's lowest level for nearly seven weeks and its sharpest decline since early July.
The decline in London was mirrored across European markets. In Frankfurt, the Dax fell 1.7 per cent, while the Cac dropped 1.9 per cent in Paris. Equities on Wall Street also suffered losses as higher energy costs weighed on sentiment.
The FTSE 100 tracks the 100 largest companies listed on the London Stock Exchange by market value. The Dax and Cac 40 represent the main stock market benchmarks in Germany and France, while Wall Street encompasses the major equity exchanges in New York.
The downturn came after Brent crude rose as high as $101.58 a barrel. Escalating hostilities in the Middle East fuelled growing fears over global oil supplies, driving energy prices higher.
Brent crude is extracted from the North Sea and serves as the international benchmark for global oil trading. Sharply higher crude prices increase costs for transport and manufacturing, feeding directly into consumer price inflation.
Kiran Ganesh, global head of investment communications at Swiss wealth manager UBS, highlighted the pressure facing equity markets.
“Higher oil prices mean higher inflation expectations, which also means higher chances of interest rate hikes and higher bond yields,” Ganesh said. “So oil is the key driver, and it’s having a compounding negative impact on equities over the past few days.”
UBS is a multinational investment bank headquartered in Switzerland that provides wealth management and institutional financial services worldwide.
Rising UK government borrowing costs
Government borrowing costs in the UK rose again as bond markets reacted to the prospect of persistent inflation and higher interest rates. Increased spending and borrowing under Andy Burnham also rattled bond investors.
The yield on 10-year gilts, a key measure of how much it costs the UK to borrow, raced towards 5.27 per cent. The rise left the yield close to last week's 19-year high of nearly 5.3 per cent.
Gilts are UK government bonds sold to institutional investors to finance public deficits. The yield represents the annualised interest rate the government pays on its debt, with higher yields raising borrowing costs for the Treasury.
The market pressure came a day after the UK paid a record 5.82 per cent interest on the sale of £4.25billion of 30-year bonds. That was the highest yield since the Debt Management Office was set up in 1998 to raise funds from investors.
The Debt Management Office is an executive agency of HM Treasury responsible for issuing sovereign debt and managing UK government cash flows. Andy Burnham is a prominent UK Labour politician whose spending proposals have drawn close attention from fixed-income investors.
Danni Hewson, head of financial analysis at investment platform AJ Bell, noted that crossing the $100 threshold carries significant weight among traders.
“The difference between a $99.99 and $100-per-barrel oil price may not mean much in practical terms but it is ringing major alarm bells for investors,” Hewson said. “Brent crude prices ticking over this mark for the first time since July is concentrating minds on mounting inflationary risks and the implications for borrowing costs.”
Hewson added that the market movement had pushed equities down internationally. “That’s helped put stocks in retreat in both Europe and the US. Selling is more pronounced on this side of the Atlantic, with the FTSE 100 faring marginally better than its French and German counterparts thanks to its heavyweight oil contingent.”
AJ Bell is a major UK-based retail investment provider. The FTSE 100 index features significant weightings in major oil producers such as Shell and BP, which can help cushion the index during periods of rising crude prices.
Central banks weigh interest rate moves
Investors are also watching upcoming central bank rate decisions closely. The Bank of England is expected to keep interest rates in the UK on hold next week, although it is feared hikes will come later in the year.
The Bank of England is the UK's central monetary authority, responsible for setting official borrowing costs to manage economic growth and keep inflation near its official 2 per cent target.
Meanwhile, the European Central Bank could raise rates in the eurozone today as European policymakers weigh inflation risks against economic growth.
Ganesh warned of the risks facing European monetary policy, stating: “There is a risk that the ECB perhaps overreacts to the move in oil prices, and then that causes a more negative impact on the rest of the economy.”
The European Central Bank, headquartered in Frankfurt, manages monetary policy and sets benchmark interest rates for the 20 European Union countries using the euro currency.
