28 Oct 2022
Graham Hook, Head of UK Government Relation and Public Policy
Rishi Sunak’s ‘coronation’ by Conservative MPs marks a return to economic orthodoxy. But further political instability may lie ahead . We look at what’s next for the economy including a Halloween budget and fiscal restraint.
It was a tenure that lasted just 44 days. But following the Prime Minister (PM) Liz Truss’s resignation, the Tory party has its third leader in as many months – and Britain has its first Asian Prime Minister.
But Rishi Sunak inherits one of the toughest in-trays of any recent Prime Minister. Not only has support for his party sunk significantly in the polls, but the deep division among Conservative MPs makes it difficult for them to unite behind him.
What will this continued political instability and uncertainty ahead mean for the country and its economy?
During the last leadership campaign, Liz Truss criticised Treasury orthodoxy and the “abacus economics of making sure that tax and spend add up”. But Treasury orthodoxy is now very much back in vogue.
The new Chancellor Jeremy Hunt is committed to presenting a “credible, transparent and fully-costed” plan to get debt falling as a share of GDP over the medium-term – and will have the full support of PM Sunak.
Bond markets have clearly demonstrated their power. The threat of future adverse market reaction will ensure fiscal policy remains wedded to the principle of presenting a balanced approach for many years to come.
Having consulted Boris Johnson, Penny Mordaunt, and Rishi Sunak over his budget plans at the weekend, the new Chancellor then went public with his backing of Sunak. So, Sunak’s appointment will be extremely welcome to Hunt – which should see a PM and Chancellor working on putting the final touches to the Halloween budget more or less in lock-step.
Hunt’s task of constructing a package of tax rises and spending cuts to fill the estimated c.£30bn hole in the public finances is a tough one though. Since there are no politically easy options, the details of the package will inevitably cause controversy.
The reaction to the budget from Tory MPs – over the days and weeks that follow – will establish the degree of authority Sunak has over his party. If the budget begins unravelling because backbench MPs won’t support the difficult measures needed to balance the books, then Sunak’s honeymoon could be short-lived.
Hunt’s reversal of most of his predecessor Kwasi Kwarteng’s tax cuts means that fiscal policy is no longer working at odds with monetary policy. This should reduce the interest rate premium that the Monetary Policy Committee would’ve had to apply had there not have been so many U-turns.
Under the new Chancellor (assuming he remains in post under the next PM), the Treasury and the Bank of England (BoE) are much more likely to work together to restore financial stability.
Truss came into office pledging an agenda of supply side reforms, including new low-tax, low-regulation investment zones.
Treasury officials will be keen to neuter these proposals, believing they will displace activity rather than generating additional private sector investment. The Chancellor may also be reluctant to proceed as their delivery would likely by classed as a net cost to the Exchequer. This would need to be offset by corresponding tax rises or spending cuts.
Some regulatory reform is likely though, like on financial services. But the lack of unity in the Tory party will mean the more controversial proposals, like planning reform, will be off the table.
Truss maligned the influence of independent institutions like the BoE and the Office for Budget Responsibility (OBR). But both emerge from the recent market and political chaos with their respective positions bolstered.
Under Chancellor Hunt, the OBR’s economic and fiscal forecasts will be the yardstick for the Halloween budget and future fiscal events.
The independence of the BoE is no longer under threat and bank officials feel sufficiently empowered to criticise government policy proposals in public. Just recently, Deputy Governor Sir Jon Cunliffe argued against Government proposals to allow ministers to call-in, rewrite or veto financial services regulations.
An early general election remains a slim possibility at this stage. Given the state of the polls, Tory MPs would effectively be voting to sack themselves should an election be called now. There’d need to be significant further fissures among Tories before an early election becomes a realistic proposition as the only way to end political instability.
Most Tory MPs will hope they can claw back some economic credibility over the next two years. The possibility of a more benign global economic backdrop might help them mitigate losses at the next election after that.
Whichever party forms the next government will face the prospect of continued fiscal restraint. For an incoming Labour government, there would be little fiscal headroom to fund higher spending on public services. With the tax burden already set to rise to its highest sustained peacetime level under Conservative plans, scope for major tax increases will be limited.
Health spending is already projected to account for almost half of day-to-day public service spending by 2024-25. Rising patient demand, the Covid backlogs and the significant number of people who are economically inactive due to healthcare issues means that an incoming Labour government is likely to have to significantly restructure the NHS.
The Labour manifesto is therefore unlikely to depart radically from the government’s spending plans at the next election.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Important Information
This is marketing material and not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
This document may not be reproduced or used for any other purpose, nor be furnished to any other person other than those to whom copies have been sent. Nothing in this document should be considered investment advice or investment marketing as defined in the Regulation of Investment Advice, Investment Marketing and Portfolio Management Law, 1995 (“the Investment Advice Law”). Investors are encouraged to seek competent investment advice from a locally licensed investment advisor prior to making any investment. Neither Invesco Ltd. Nor its subsidiaries are licensed under the Investment Advice Law, nor does it carry the insurance as required of a licensee thereunder
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals, they are subject to change without notice and are not to be construed as investment advice.