Labour’s economic pessimism halts UK equity market recovery, triggering significant outflows

The UK’s equity markets have taken a hit as the Labour government’s pessimistic portrayal of the country’s economic outlook reverses a brief recovery in investor interest.

New figures from Calastone, a global fund network, show that UK-focused funds suffered net withdrawals of £666 million in September, while other geographically focused fund sectors recorded inflows.

Overall, global investors pulled a net £564 million from fund holdings, marking the end of a ten-month streak of near-record inflows. Equity income funds, which have significant exposure to UK equities, lost £416 million in capital. According to Calastone, UK-focused equity funds have not seen positive net inflows since 2021.

The decline in investor sentiment comes amid criticism of Labour’s portrayal of the UK economy since taking office in July. Chancellor Rachel Reeves and Prime Minister Sir Keir Starmer have faced backlash from the City for painting what some consider an overly negative picture of the public finances. Reeves has stated that the government inherited the worst economic conditions since World War II, citing a £22 billion “black hole” in public finances left by the previous Conservative administration.

Edward Glyn, head of global markets at Calastone, remarked that the government’s “rather pessimistic commentary” has dampened the nascent revival of interest in UK equities observed in July. “UK-focused funds seem to be off the menu for investors for the time being,” Glyn said.

This bearish shift in sentiment is reinforced by other recent data. A long-standing consumer confidence index plunged to its lowest level since January, while optimism among manufacturers has declined at the fastest rate since the pandemic began.

Adding to the financial turbulence, Calastone also reported the “biggest outflows from fixed income funds on its ten-year record” since the start of August, driven by expectations of interest rate cuts by central banks. The combined net outflows of £1.3 billion have largely been reallocated to safer assets.

The global trend towards loosening monetary policy has played a role in this shift. Last month, the US Federal Reserve lowered borrowing costs by 50 basis points, and it is expected to continue easing policy, along with the European Central Bank. The Bank of England is also forecast to cut its base rate by another 25 basis points in November, as inflation eases.

With the budget approaching on 30th October, Rachel Reeves is expected to raise taxes, but the fiscal tightening will be partly offset by increased public investment spending. The government’s strategy will be closely watched by investors who remain cautious about UK equities amidst the gloomy economic narrative.

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Labour’s economic pessimism halts UK equity market recovery, triggering significant outflows