The Bank of England governor’s warning that interest rates may have to rise sooner than expected hit the UK stock market, which was already rattled by a spike in the oil price caused by the insurgency in Iraq.
The FTSE 100 tumbled 84 points or 1.2% to 6,760 as investors sold house builders and property stocks. These have benefited greatly from the five-year period of near zero interest rates, which is now drawing to an end.
Ashtead Group (AHT), the tool hire company that has done well from the construction boom in the UK and the US, was the FTSE 100’s second biggest faller, down 4.3%.
New figures from the Office for National Statistics confirmed the boom in construction and the positive impact on economic growth. The ONS said construction output rose 1.2% in April compared to March and hiked its first quarter estimate from 0.6% to 1.6%.
Chris Williamson, economist at Markit, the financial data provider, said this could lift first quarter growth for the economy to 0.9%, the strongest rate of expansion in nearly four years.
Williamson said the speed of recovery and the rapid fall in unemployment, in particular, had surprised the Bank of England. In terms of timing of the first rate rise he said: ‘November seems a distinct possibility, as that is when the Bank updates its forecasts in its quarterly Inflation Report. However, perhaps we should also not rule out a hike when the August Report is published, if the economic data continue to surprise to the upside in coming months, especially in relation to wages.’
This shocked some investors. Although the Bank’s monetary policy committee has been under pressure to respond to the rapidly improving UK economy, which is good news, it was widely expected to hold off a painful increase in borrowing costs until after the general election in spring.
Expectation of the first rate rise by the end of the year pushed the pound to $1.6963 against the dollar as UK interest rates will now probably rise at least six months before they do in the US.
The price of UK government bonds, or gilts, slid with five-year yields rising to 2.1% and 10-year yields advancing to 2.74%, indicating where investors think interest rates are going.
Carney stressed that the early move on rates would not change the Bank’s overall stance of keeping the cost of borrowing lower for longer, to avoid hurting indebted households and businesses.
Stewart Cowley, manager of the Old Mutual Global Strategic Bond fund, said it was too soon to sound the all-clear for the UK’s public finances as the country still had a £100 billion budget deficit.
'Income tax receipts are lagging even as unemployment falls and the economy is growing. On top of this we are still very dependent on external financing – our overall annual deficit with the rest of the world has continued to deteriorate. No administration – even after the next general election – should take the (expected) ratings agencies verdicts as a sign that they can stop concentrating on making sure our finances are put on a sound footing,' he said.
The nervousness of markets was heightened after President Obama indicated he might order air strikes to support the Iraqi government against Islamic insurgents who are advancing towards the country’s capital, Baghdad. Iraq is the second biggest producer in the Opec oil cartel. The price of Brent crude oil hit a six-month high of $113.59 a barrel on fears supply could be disrupted.
Gold firmed half a dollar to a high for the month of $1,274.1 an ounce as investors sought the safe haven amid the uncertainty.
Look at the week with our 'Accumulator' table
Even before today's fall, it had been a tricky week for stock markets in the developed world, particularly the US.
As our weekly Accumulator table shows, in the week to the end of Thursday, the US S&P 500 fell 1.3% in sterling terms, wiht the FTSE 100 down just 0.1% before today's scare.
Brazil’s stock market rallied 3.7% in sterling terms, although this is less to do with the World Cup and more about polls showing a further decline in popularity for President Dilma Rousseff whose left-wing policies are disliked by investors.