Rishi Sunak, Britain’s third prime minister in seven weeks, will face the huge challenge of projecting stability after a period of historic political and financial market turmoil. But his other task — shepherding the country through recession — is poised to be just as daunting.
The former Chancellor of the Exchequer has won the race to replace Liz Truss, his former rival, who is set to be the shortest-serving prime minister in British history. He will officially step into the role once appointed by King Charles III.
The pound sterling rose against the US dollar as Sunak’s path to power became clear with the exit of rival Boris Johnson earlier on Monday, but last fell 0.2% to $1.128. The yield on the UK 10-year bond, which moves against prices, fell to 3.82%.
Sunak campaigned over the summer with promises to help households cope with the rising cost of living, prompting many to cut back on spending. He said he would cut taxes, but only once did the pressure on prices ease.
However, the economic outlook has worsened significantly since then – not least because of the market turmoil caused by the now-abandoned Truss plan to cut taxes as quickly as possible and increase the public debt.
A closely watched indicator of economic activity fell to a 21-month low in October. S&P Global, which tracks the data, said it effectively confirms the UK is in recession.
“Increasing political and economic uncertainty has led to a slowdown in business activity that has slowed since the 2009 global financial crisis, excluding months of pandemic lockdowns,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.
As the Truss’s disastrous tax cut plan proved, any economic stimulus beyond immediate support for energy bills could be a trigger for Sunak.
Carl Emmerson, deputy director of the Institute for Fiscal Research, said in a statement, “A key focus for the next prime minister and their chosen chancellor must be fiscal responsibility.” “We need a credible plan to meet government debt in the medium term.”
Although a senior Bank of England official said last week that investors may be pricing in too much interest rate hikes, the central bank is expected to remain tough in its campaign to keep inflation under control for the foreseeable future.
The Bank of England predicted last month that the UK economy is already in recession. Evidence is mounting to support this view. The country’s output fell 0.3% in August, after expanding just 0.1% in July.
A government report released Friday showed retail sales fell 1.4 percent in September, a worse-than-expected decline. And consumer confidence is near its worst level on record as inflation returns to 40-year lows.
Dean Turner, an economist at UBS Wealth Management, called the spending outlook “very dire, to say the least.” The main questions now, he said, are how long the contraction will last and how deep it will go.
The UK financial picture also darkened with data released on Friday showing the British government borrowed 20 billion pounds ($22 billion) in September, up from 5.2 billion pounds ($5.7 billion ) is more than the financial inspector of the country expected.
“The weakness of retail sales and the overshooting of the government debt forecast in March by the Office for Budget Responsibility will not make the task of the next prime minister easier to lead the economy through the cost of living crisis, the cost of debt crisis and the cost of confidence crisis,” Ruth Gregory, chief UK economist at Capital Economics, in Note to customers.
Investors and economists expect the current finance minister Jeremy Hunt’s economic restructuring plan to remain unchanged.
Last week, Hunt – just days into office – announced the roll back of nearly all the tax cuts in Truss’ “growth plan”, which investors rejected.
Citing new commitments to control the country’s debt, Hunt also said the government would cap electricity prices only until April. The support after that would cost taxpayers “significantly less than the plan,” he added.
“Whoever becomes prime minister – and even if they decide to replace the chancellor – it seems to me that the fiscal path is very difficult because the markets cannot tolerate anything other than what is on the table” Turner said.
That could help stabilize financial markets, although tighter assurances and more details on budget plans would be welcome at a time when bond markets around the world are showing signs of strain, said James Atey, chief investment officer at Abrdn, an asset manager.
“This again hits the pause button on attracting international investors,” Atey said.
There is also some uncertainty about the Bank of England’s next steps. Ben Broadbent, deputy director of monetary policy, warned last Thursday that investors may be ahead of themselves in projecting a rate hike amid the recent turmoil.
“Should official interest rates rise to the extent that financial markets are currently pricing in,” he said in a speech.
The central bank is expected to be very dovish in its November and December meetings. If the economy slows down sharply next year, it may bounce back later. That said, if the government withdraws some support for energy bills in April, that could reinvigorate inflationary pressures – once again complicating the bill.
“Let’s be honest, we don’t know what energy prices are going to be in April, so we don’t know how that’s going to affect the household budget,” Turner said.
This allows investors to speculate for a long time and economists to wait for revisions to their forecasts.
“Unfortunately, clarity and certainty are lacking,” Atey said.