Rishi Sunak is the UK’s new Prime Minister (PM), but what does it mean for the economy? A few early thoughts below.
Given his previous experience as Chancellor, as well as comments criticising Truss’s fiscal policies over the summer’s leadership campaign, he is seen as a ‘safe pair of hands’ for now. Sunak as PM is therefore arguably somewhat of a short-cut to (at least partly) restoring institutional credibility. All of that may give him some leeway to, for example, backload some of the required fiscal consolidation measures. In his opening statement as PM in Downing Street he made clear reference to the 2019 election manifesto, rather than indicating another big shift in Conservative policy priorities.
Nonetheless, he will need to follow through with a credible set of fiscal measures given the hole in the fiscal finances that has opened up. I would assume for now that we won’t see much change to the tax cut U-turns already announced by Chancellor Hunt (at the time of writing it was not confirmed that Chancellor Hunt would remain in his role, but was widely expected to be the case). However:
- PM Sunak may want to change some of the decisions made by Hunt. He might decide to re-instate the health and social care levy/National Insurance contribution rise, for example, which was one of the most expensive tax cut measures under Truss.
- It is not clear whether Sunak would be on board with significant government spending cuts. Under Sunak, a more back-loaded fiscal tightening looks plausible.
- As the UK has lost some fiscal/institutional credibility, throwing money at a given problem is less of an option than it was for Sunak in the pandemic period or at the start of the energy crisis.
- It is unclear how far Sunak will be able to heal party divisions and therefore he may struggle to pass some parts of any policy programme. Although if the 2019 election manifesto is again to be the core driver of policymaking priorities, that may be less problematic.
Whatever the exact make up of fiscal policy that emerges in coming weeks, however, beyond support for energy bills, it is unlikely to look particularly supportive for the economy – especially once combined with the likely monetary policy path.
In the meantime, UK economic data is looking increasingly recessionary and it seems likely that the UK entered recession in Q3. If GDP was flat in September, then mechanically (assuming no back revisions), Q3 GDP is tracking a fall of around 0.4%Q in Q3. Meanwhile the recent Purchasing Managers’ Index (PMI) business surveys suggest that the pace of contraction in private sector activity has picked up at the start of Q4 (not helped by political uncertainty). Although the temporary energy bill freeze is an important bulwark against a deep UK recession, a more modest recession – though somewhat deeper than I’d expected just a few weeks ago – looks unavoidable.
As for the Bank of England (BoE), although the tax U-turns were already set to make for a less supportive fiscal environment, inflationary pressures remain strong. The September Consumer Price Index figures and the most recent pay figures were consistent with robust domestic inflationary pressure. With the UK labour market still looking tight and inflation very high, further hikes are likely from the BoE – albeit with less urgency and perhaps to a lower terminal rate than looked likely when the Truss mini-Budget was published. Monetary Policy Committee members Broadbent and Mann have both hinted/said that the market has been too aggressively priced on rates where the terminal rate priced into markets late last week still looked above 5%. Although a 75bps rate hike in November now looks more likely than a 100bps rate hike, my forecast for the peak in UK rates remains 4.5% albeit with plenty of uncertainty in either direction still attached to that central case. The shape of fiscal policy remains important for the path of monetary policy and that is still somewhat uncertain ahead of further fiscal announcements from the government and the next set of Office for Budget Responsibility forecasts.
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