UK markets moved into positive territory following a volatile week, with the FTSE 100 rising 0.33% to around 10,530 points at the time of writing.
The Iran war has reportedly created a nearly £12 billion hole in Britain’s public finances, according to estimates from the Financial Times, potentially halving the Chancellor, John Healey’s fiscal headroom from the £23.6 billion forecast by the Office for Budget Responsibility in March.
Higher borrowing costs and changes to economic forecasts have significantly reduced the government’s financial flexibility, increasing the likelihood of tax rises and spending cuts in the Budget on 28 October. Around £10 billion of the estimated reduction stems from higher interest payments on government debt, with the remainder reflecting changes to growth, earnings and inflation expectations.
UK borrowing costs rose alongside other European markets on Thursday, pushing the 10-year gilt yield as high as 5.53%, its highest level since 2007, before easing to close at 5.49%. The government’s fiscal rules require day-to-day spending to be covered by revenues by 2029-30, with headroom providing a financial buffer against unexpected economic shocks. The reduction in this buffer could leave the Chancellor with difficult decisions as the government seeks to maintain investor confidence while supporting households facing higher living costs.
Measures to ease energy bills are expected to feature prominently, alongside potential support for small businesses. Prime Minister Andy Burnham has previously proposed a 20% reduction in business rates for pubs, social clubs and live venues.
Elsewhere, the UK housing market weakened in September as higher mortgage rates and economic uncertainty continued to weigh on demand. The Royal Institution of Chartered Surveyors reported that its measure of new buyer enquiries fell to -22 from -18 in August, while agreed sales declined to -18 from -16. The measure for house prices also deteriorated, falling to -32 from -28. The indices measure the difference between the share of estate agents reporting rising and falling enquiries, sales or prices. The figures suggest that rising borrowing costs are placing further pressure on household finances, discouraging prospective buyers and contributing to a broader slowdown in the property market.
Commodity markets
In commodity markets, Brent crude futures traded around $103 per barrel on Friday and are on course for a weekly gain, as escalating tensions in the Middle East threatened global oil supplies.
Iran intensified attacks on tankers navigating the Strait of Hormuz, with nine vessels reportedly targeted over the past week. Meanwhile, Hurricane Isaias threatened offshore oil production in the Gulf of Mexico, prompting producers to shut in approximately 1.3 million barrels per day of crude output. Oil prices subsequently retreated towards the end of the week as concerns over Middle Eastern supply disruptions eased.
US President Donald Trump said Washington was holding productive discussions with Iran and would not attack the country before the US midterm elections on 3 November. Iran’s Tasnim news agency reported that Foreign Minister Abbas Araqchi was reviewing Washington’s response to Tehran’s proposal to reopen the Strait of Hormuz within seven days. However, the US continued to apply economic pressure, imposing sanctions on Thursday against individuals, networks and 17 vessels allegedly involved in transporting Iranian crude oil, petroleum products and petrochemicals.
Meanwhile, China, the world’s largest oil importer, is preparing to resume refined fuel exports following a temporary suspension during its Golden Week holiday, potentially providing some relief to tight global supply conditions.
Gold prices traded around $4,180 per ounce on Friday and are on course to finish the week unchanged. Investors continued to weigh persistent inflation concerns against the outlook for US interest rates, with expectations for Federal Reserve policy remaining an important influence on the precious metal. Higher interest rates can weigh on gold by increasing the opportunity cost of holding the non-yielding asset, although geopolitical uncertainty continues to provide a potential source of support.
Equity markets
US equity futures rose on Friday following reports that OpenAI expects annualised revenue to reach or exceed $70 billion by year-end, easing concerns sparked by earlier reports that revenue was running $20 billion below previously indicated levels.
In Thursday’s trading session, the Dow Jones Industrial Average gained 0.10%, while the S&P 500 fell 0.47% and the Nasdaq Composite declined 1.25%. Investors are preparing for another quarter of strong corporate earnings, supported by substantial investment in artificial intelligence infrastructure. S&P 500 earnings are forecast to have increased 27% year-on-year in the September quarter, according to Goldman Sachs, marking a third consecutive quarter of growth above 25%. Revenue is expected to rise 12%, while FactSet reported that all 11 S&P 500 sectors are forecast to deliver earnings growth. A record 72 companies have also issued positive earnings guidance for the quarter, suggesting that corporate performance remains resilient. However, concerns persist over the sustainability of AI-related investment and the market’s growing reliance on a small group of technology companies.
Meanwhile, rising government bond yields are increasing borrowing costs across corporate America, particularly for businesses with weaker credit ratings. Borrowing costs for the lowest-rated companies reached 17% this month, their highest level since May 2020, while the additional premium investors demand to lend to companies rated triple-C or below rose to its highest level since 2022. Companies with floating-rate loans or significant refinancing requirements are particularly vulnerable. Reflecting the more challenging environment, Bank of America reduced its forecast for October’s investment-grade corporate bond issuance to $110 billion from approximately $160 billion. However, demand for artificial intelligence infrastructure continues to support borrowing by some highly rated companies, despite higher financing costs.
Elsewhere, minutes from the latest Federal Reserve meeting indicated that most policymakers considered another interest-rate increase before year-end potentially appropriate, although there was no clear consensus in favour of a prolonged series of hikes. Persistent inflation and resilient economic activity continue to complicate the outlook for monetary policy, leaving investors focused on upcoming economic data and corporate earnings for further indications of the direction of interest rates.
The information provided in this communication is not advice or a personal recommendation, and you should not make any investment decisions on the basis of it. If you are unsure of whether an investment is right for you, please seek advice. If you choose to invest, your capital may be at risk and the value of an investment may fall as well as rise in value, so you could get back less than you originally invested.