Analysis-Political woes and economic funk mean few takers for British assets

By Tommy Wilkes and Joice Alves

LONDON (Reuters) - A potent mix of weak growth, high inflation, and a new bout of political instability means no respite in sight for British assets struggling to find interest from investors.

British stocks, bonds and the sterling are all feeling the malaise this summer, and optimism the outlook will improve remains muted after Boris Johnson said he would resign as British prime minister.

Laura Foll, a fund manager who focuses on the UK market, for example, says she can point to many British companies whose shares are cheap. But few others see it that way, she says.

"We find very lowly valued firms versus where they have historically traded, but it's not helping the share price. There just isn't that marginal buyer"," said the manager at Janus Henderson Investors.

Whoever takes over from Johnson faces a highly uncertain economic backdrop that looks tougher than in other developed countries, regardless of how the politics play out.

Even if some investors expect a new government to unleash populist spending measures to boost support, room for manoeuvre is limited given the inflationary heat in the economy.

The pound, at two-year lows against the dollar, shrugged at Johnson's resignation, suggesting that after months of scandals and instability British politics has lost the power to shock markets.

"Boris Johnson's resignation does little to change the macroeconomic reality for the UK or the market reality for the pound," said Tim Graf, head of EMEA macro strategy at State Street. "The toxic mix of rising household costs...and slowing growth look likely to test any future leader."

Foreign investors have voted with their feet since the UK referendum in 2016 to leave the European Union, and there's been no let up. In the first six months of 2022, investors pulled a net 11.3 billion pounds from British equity funds, Lipper data shows, their largest ever half-yearly outflow.

In contrast, global stock funds, also weakened by rising interest rates, have received net investment inflows of 31.3 billion pounds, according to Lipper.

Investor outflows are particularly bad news at a time when Britain's trading strength has weakened. It racked up a record balance of payments deficit in the first quarter of the year of 8.3% of gross domestic product, a figure that may be revised..

(Graphic: UK current account, https://fingfx.thomsonreuters.com/gfx/mkt/klpykrxmjpg/Pasted%20image%201657203014119.png)

The International Monetary Fund predicts Britain will be the worst economic performer of the G7 in 2023.

"The UK economic situation is pretty frightening. I think we're set to have the worst performance out of the G7, perhaps even the G20, going forward," said Mark Peden, investment manager, global equities, at Aegon Asset Management.

"I certainly wouldn't be exposed to the UK consumer at all."

OUTFLOWS

With inflation forecast to hit 11% in 2022, consumers are indeed reining in spending, with retailers such as appliance retailer Currys and supermarket Sainsbury warning this week about falling sales.

The commodity-heavy FTSE 100 has outperformed wider equity markets in 2022, but the FTSE 250 index of smaller, more UK-focused companies has fallen 20% -- in line with the MSCI World index.

Funds invested in small and mid-cap UK companies have endured year-to-date net outflows of 3.2 billion pounds, according to Lipper, more than any year since at least 2000.

There are headwinds now for the FTSE 100 too if the deteriorating global picture hurts commodity prices.

"If there is a global recession, the FTSE is going to be taking the brunt of it as well," said Salman Baig, a portfolio manager at asset manager Unigestion.

TIGHTROPE WALKING

Watching decades-high inflation and interest rates on the rise, investors have also been dumping British bonds this year, data from eVestment shows - although that is a trend seen globally with investors exiting fixed income assets.

(Graphic: UK GDP, https://fingfx.thomsonreuters.com/gfx/mkt/lbvgnxkyxpq/Pasted%20image%201657140705736.png)

A new British government might implement tax cuts and spending increases to boost growth and woo voters. But as the Office for Budget Responsibility warned on Thursday, Britain's debt burden could more than triple over the next 50 years to 320% of annual GDP unless taxes are raised.

It leaves the BoE in an unenviable position. Governor Andrew Bailey has said UK inflation will remain persistently high for longer than in other economies, even as economic momentum slows.

Even after its 12% year-to-date drop, speculators are betting sterling will fall further, positioning data from the Commodity Futures Trading Commission shows.

Sunil Krishnan, head of multi-asset funds at Aviva Investors, has been buying UK government bonds, believing the BoE will hit pause on hiking before rates near the levels of as much as 3% by March next year that the market is forecasting.

Every central banker is walking a tightrope in trying to tame inflation without triggering recession, Krishnan told Reuters, but in Britain that tightrope is "even narrower and wobblier".

(Additional reporting by Samuel Indyk; Editing by Sujata Rao and Deepa Babington)