Johnson is Going – What This Means For The Economy

Johnson

Johnson formally resigned as leader of the Conservative Party last Thursday but said he would stay in Downing Street until a successor is chosen. The removal of the prime minister comes at a particularly precarious time for the British economy. The nation is experiencing a crisis related to the cost of living as inflation reached a fresh 40-year high of 9.1% in May.

According to AXA IM’s Adegbembo, “The immediate outlook is likely to hinge on whether Johnson manages to stay on for the next two months – in which case markets risk a period of additional volatility going into the summer.”

Economists predict that the eventual replacement for UK Prime Minister Boris Johnson will result in more financial assistance and less tense ties with the EU.

On Thursday, Johnson officially resigned as the head of the Conservative Party. Despite calls for him to stand down right away and give a less contentious “caretaker” the reins in the meantime, Johnson indicated he would remain in Downing Street until a replacement is found.

Although it’s unclear exactly when a new leader will be chosen, rumours indicate that the goal is to have one in place by the Conservative Party conference in October. Rishi Sunak, Penny Mordaunt, and Liz Truss were the favourites among the 11 contenders who had joined the contest to succeed Johnson according to British bookmakers.

The removal of the prime minister comes at a particularly precarious time for the British economy. May saw a record 40-year high for inflation of 9.1% as the nation’s cost-of-living issue was exacerbated by skyrocketing food and energy prices.

The UK is anticipated to enter a technical recession in the second half of the year, and the unexpected contraction in the economy in April marked the first consecutive GDP reductions since the start of the Covid-19 epidemic.

As household spending power continues to be constrained, the Office for Budget Responsibility, the UK’s independent fiscal watchdog, forecasts that real disposable incomes would shrink by 2.2% this fiscal year (2022/2023), the greatest yearly loss since records have been kept.

“Additionally, the uncertainty around the duration and outcome of the conflict in Ukraine is likely to adversely affect investments, as well as an export performance via secondary effects on the growth outlook for the EU, the U.K.’s key trading partner,” said Boris Glass, senior U.K. economist at S&P Global Ratings.

“Given the aforementioned inflation squeeze, the Bank of England’s (BOE’s) tightening of monetary policy, and no end in sight to the Russia-Ukraine conflict, we project 1% growth for the UK for 2023, the lowest rate among G-7 countries.”

Fiscal Support

In an effort to combat the cost-of-living crisis, the former finance minister Rishi Sunak announced a number of measures over the past six months, including a windfall tax on oil and gas majors and a one-time payment to 8 million of the lowest-income households. Sunak’s resignation was one of two that ultimately led to Johnson’s resignation.

However, experts anticipate that whoever succeeds Johnson would further increase budgetary assistance for the faltering economy.

Modupe Adegbembo, a G-7 economist at AXA Investment Management, said a key question is whether Johnson uses his “caretaker” period as prime minister — should he be granted one — to push through 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 Thursday.

“The potential to accelerate income tax cuts pencilled in for 2024 may be floated by some candidates, although remains challenging in the light of public finance developments.”

Her comments were echoed by strategists at UBS, who said a change in leadership makes further fiscal support more likely as a new prime minister will “want to prove themselves.”

“Any additional support for the UK economy would come at an opportune moment: The GDP growth estimate for March was –0.1% compared to February, and for April it was –0.3% versus March,” UBS CIO (Chief Investment Officer) Mark Haefele’s team said in a note Friday.

“Another increase to the energy price cap means there is further pressure ahead, but while our base case is that the UK will narrowly escape recession, it is important to remember that the FTSE 100 generates just 25% of its revenues inside the UK”.

As a result, UK large-cap equities are less susceptible to local economic development and gain from the weakening of the pound; many FTSE 100 businesses generate their profits in dollars, so they benefit when the pound declines in value relative to the dollar.

According to strategists at asset management Invesco, investors may have possibilities to buy “high-quality, international companies at a double discount” as long as sterling stays weak.

Following Johnson’s departure, sterling somewhat increased, but on Friday as global pressures persisted, it lost some of those gains. The FTSE 100 has remained largely impervious to the political turmoil, tracking gains across Europe.

UBS (Union Bank of Switzerland) also observed that the UK market has recently been supported and has become one of the Swiss Bank’s favourite equities markets due to its large exposure to both commodity-linked and “value” sectors, or firms that often trade at a discount to their fundamentals.

“The immediate outlook is likely to hinge on whether Johnson manages to stay on for the next two months – in which case markets risk a period of additional volatility going into the summer,” AXA IM’s Adegbembo said.

“However, if Johnson were replaced by another ‘caretaker’, the prospect of domestic policymaking would fall, something which should reduce any expected volatility.”

The Brexit Challenge

There isn’t a single candidate who has clearly emerged as the Conservatives’ next leader, and the field is likely to be big and varied. The acceptance of any fiscal measures to assist consumers is not certain, even if a new Prime Minister takes office in Downing Street.

According to Invesco, because of this uncertainty, the UK economy will continue to “wither” in the meantime and is most likely to undergo a recession this year compared among other developed countries.

The UK is grappling with the trade and economic ramifications from Brexit, which Invesco’s multi-asset team said were feeding the inflationary fire on food and energy prices, in addition to the global pressures of supply chain issues and the conflict in Ukraine.

“It’s hard to turn more constructive on the UK economy right now. Not only are economic fundamentals weakening, but the profound risk of a policy error is significant,” Invesco strategists said.

“Given the current pressures, we think it’s become even harder for the government to unify around a clear strategy going forward.”

Johnson’s government has been at odds with Brussels over the implementation of the Northern Ireland protocol, a crucial tenet of the withdrawal agreement that both parties signed, despite being elected in 2019 on a promise to “Get Brexit Done” and touting his “oven-ready” exit deal with the European Union.

According to S&P Global’s Glass, a new administration may attempt to mend ties with the EU by adopting a more accommodative stance toward trade relations, but this conclusion is far from certain given the diversity of opinions within the Conservative Party.

“Judging by the early line-up of potential successors to Johnson, the balance of potential outcomes would tilt towards less strained relations with the EU,″ said Berenberg Senior Economist Kallum Pickering.

“Even the ardent Brexiteer candidates (Penny Mordaunt and Liz Truss) are less of the populist variety than Johnson.”

Long Term Optimism

Over time, less fraught relations with the EU may also prove to be a catalyst for stronger business investment, offering a sustained higher path for sterling towards a fair value of £1.40-£1.45 against the US 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 unthinkable for late-2022 or early-2023. Both Johnson and May took the UK to the polls soon after becoming Conservative leader,” he added.

Beyond the immediate political volatility, however, Glass argued that the UK continues to benefit from “strong institutional settings and a credible monetary policy.”

In an effort to combat inflation, the Bank of England has started raising interest rates. According to S&P Global, by mid-2024, consumer prices will have steadily stabilised.

“Moreover, despite a weakening of the macroeconomic outlook, public finances have been stabilizing overall, with net general government debt projected to fall to 94% of GDP by 2025 from 96% at the end of 2021,” Glass said.

online sources: cnbc.com, yahoo.finance.com

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