Henry Nicholls | Reuters LONDON — The eventual successor to U.K. Prime Minister Boris Johnson is likely to bring more fiscal support and less fractious relations with the European Union, economists say. Johnson formally stepped down as leader of the Conservative Party on Thursday but said he would remain in Downing Street until a successor is chosen – despite many calling for him to step down immediately and allow a less controversial “caretaker” to take over in the interim. Exactly when a new leader will be appointed is unclear, but reports suggest the aim is to have one confirmed before the Conservative Party conference in October. By Monday morning, 11 candidates had entered the race to replace Johnson with Rishi Sunak, Penny Mordaunt and Liz Truss the favourites, according to British bookmakers. The Prime Minister’s ouster comes at a particularly dangerous time for the UK economy. Inflation hit a new 40-year high of 9.1 percent in May as rising food and energy costs deepened the country’s cost-of-living crisis. Meanwhile, the economy shrank unexpectedly in April to mark the first consecutive contractions in GDP since the start of the Covid-19 pandemic — and the UK is widely tipped to experience a technical recession in the second half of the year. The Office for Budget Responsibility, the UK’s independent fiscal body, has forecast that real disposable income will fall by 2.2% this financial year (2022/2023), the biggest annual fall since records began, as the squeeze on household spending power continues. “Furthermore, uncertainty over the duration and outcome of the conflict in Ukraine is likely to negatively impact investment as well as export performance through knock-on effects on the growth outlook for the EU, the UK’s main trading partner,” said Boris Glass, Senior Clerk. UK Economist at S&P Global Ratings. “Given the aforementioned compression of inflation, the tightening of monetary policy by the Bank of England (BOE) and no end in sight to the Russia-Ukraine conflict, we forecast 1% growth for the UK in 2023, the lowest among the G-7. .”
Financial support
Former finance minister Rishi Sunak, whose resignation was one of two that triggered the eventual end of Johnson’s tenure, has announced a raft of measures over the past six months in a bid to combat the cost of living crisis, including a surprise tax on oil and natural gas. and a lump sum payment to the lowest 8 million households. However, economists generally expect that whichever candidate takes over from Johnson will raise the forecast for fiscal support for the troubled economy. Modupe Adegbembo, G-7 economist at AXA Investment Management, said a key question is whether Johnson is using his “service” period as prime minister — if granted — to advance short-term fiscal policies. “However, when a new Prime Minister is appointed, we see an increased likelihood of additional fiscal spending and/or tax cuts,” Adegbembo said in a note on Thursday. “The possibility of an acceleration of the income tax cuts forecast for 2024 may be seen by some candidates, although it remains challenging in light of developments in public finances.” Her comments were echoed by UBS strategists, who said a change in leadership made further fiscal support more likely as a new prime minister “will want to prove himself”. “Any additional support for the UK economy would come at an opportune time: the estimate for GDP growth for March was -0.1% compared to February and for April it was -0.3% compared to March,” UBS CIO Mark Haefele’s team said in a note. Friday. “Another increase in the energy price cap means there is further pressure ahead, but while our basic assumption is that the UK will briefly escape recession, it is important to remember that the FTSE 100 produces just 25% of his income within the United Kingdom’. As such, UK large-cap stocks are not particularly sensitive to domestic economic growth and benefit from the weakness of the pound. Many FTSE 100 companies make profits in dollars, which are therefore strengthened when the pound weakens against the dollar. Strategists at Invesco Asset Management agreed, stressing that as long as sterling remains weak, investors may have opportunities to buy “high-quality, double-discounted international companies”. Sterling rose fractionally after Johnson’s resignation, but gave back those gains and then some on Friday as global pressures continued to weigh on the pound. The FTSE 100 remained largely impervious to the political turmoil, tracking gains across Europe. UBS also noted that high exposure to both commodity-linked and “value” sectors – stocks that typically trade at a discount to their fundamentals – has supported the UK market of late and made it a from the Swiss bank’s preferred stock markets. “The immediate outlook is likely to depend on whether Johnson manages to hang on for the next couple of months – so markets risk a period of additional volatility starting in the summer,” AXA IM’s Adegbembo said. “However, if Johnson is replaced by another ‘caretaker’, the prospect of domestic policy-making would diminish, reducing any expected volatility.”
The Brexit problem
No clear front-runner has emerged to take over as Conservative leader, with the field likely to be crowded and diverse. But even when a new prime minister moves into Downing Street, the approval of any fiscal package to help consumers is not a foregone conclusion. Invesco suggested that this uncertainty means the UK economy will continue to “wither” in the interim and is most likely among developed economies to experience a recession this year. Along with the global pressures of supply chain problems and the war in Ukraine, the UK is also grappling with the trade and economic fallout from Brexit, which Invesco’s multi-asset group said fueled the inflationary fire in food and energy bills. “It is difficult to turn more constructively on the UK economy at the moment. Not only are economic fundamentals weakening, but the deep risk of a policy mistake is significant,” Invesco strategists said. “Given the current pressures, we believe it has become even more difficult for the government to unite around a clear strategy going forward.” Despite being elected in 2019 on a promise to “Get Brexit Done” and touting his exit deal with the European Union, Johnson’s government has continued to spar with Brussels over the operation of the Northern Ireland protocol, a key tenet the withdrawal agreement signed by both parties. S&P Global’s Glass suggested that a new government may try to mend relations with the EU by taking a more conciliatory approach to trade relations, but that outcome is far from guaranteed given the range of views within the Conservative Party. “Judging by the early line-up of potential successors to Johnson, the balance of likely outcomes will tilt towards less strained relations with the EU,” said Berenberg senior economist Callum Pickering. “Even the staunch Brexite candidates (Penny Mordant and Liz Truss) are less of the populist variety than Johnson.”
Reason for long-term optimism?
Over time, less rocky relations with the EU may also prove a catalyst for stronger business investment, offering a steady path higher for sterling towards a fair value of 1.40-1.45 against the dollar and 1.20- 1.25 against the euro, Pickering suggested. “Looking further out, a Conservative leadership election followed by a snap election during the new leader’s honeymoon phase is not inconceivable for late 2022 or early 2023. Both Johnson and May led the UK at the polls immediately after the Conservative leader is elected,” it added. Beyond the immediate political instability, however, Glass argued that the UK continues to benefit from “strong institutional arrangements and a credible monetary policy”. The Bank of England has started raising interest rates in a bid to contain inflation, and S&P Global believes consumer prices will gradually come under control by mid-2024. “Furthermore, despite the weakening macroeconomic outlook, public finances are stabilizing overall, with general government net debt forecast to decline to 94% of GDP by 2025 from 96% at the end of 2021,” Glass said.
