HomeBlogFinanceUK stocks: sterling collapse has few silver linings

UK stocks: sterling collapse has few silver linings

A resounding foghorn of no confidence on the UK economy resonates through markets. Early on Monday, in response to plans by the government of Liz Truss to enact debt funded tax cuts, the pound fell to its cheapest ever against the dollar. Gilt and UK corporate credit yields soared to the highest levels in a decade. Volatility more commonly seen in the emerging markets highlights the country’s worsening economic prospects.

The debate in the UK has squarely shifted from how likely to how deep a recession should now follow. The UK’s 9.9 per cent inflation outpaces that of the EU, United States and Japan. Weaker sterling only exacerbates the problem of high imported energy costs, just as domestic interest rates accelerate upward.

Some companies will benefit from the weaker currency. Out of the 2,000 largest listed non-financial UK groups, about 40 per cent of sales originate in the US, according to data from S&P Global. Natural resource producers — which primarily earn in dollars — provide half that. Big beneficiaries from weaker sterling include exporters such as aviation group Rolls-Royce and engineering peers Smiths and Spirax Sarco. Their share prices rose on Monday.

However, domestic corporate credit risk is rising. Spreads on UK investment grade bonds have risen sharply this year to five-year highs. No wonder. As the economic slowdown has crimped profitability, the number of UK companies with interest cover (operating profits divided by interest expense) below one exceeds that of most EU countries.

UK insolvencies in August were 43 per cent higher than the year before, and about the same percentage versus 2019. It should get worse. Overleveraged pub operators such as Marston’s and Mitchells & Butlers have already warned of the threat of inflation to their finances. Neither low cost airline easyJet nor online grocery Ocado can cover their interest expenses with operating profit.

During the pandemic the UK government could cushion the blow of the pandemic. The force of the coming recession will decide how far those buffers are put to the test.

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