Vers une sortie de Boris du gouvernement britannique
The UK has suffered from political divisions over Brexit for six years. Since a relatively hard Brexit was negotiated under the current government there have been increased signs of stresses emerging in trade and in labour markets starved of the ability to hire EU citizens in the same way they could in the past. Covid and the energy crisis have added to economic difficulties and the Boris Johnson government has strayed from the typical characterization of Conservatives by overseeing a record tax burden and largesse in public spending. It’s over for Johnson and it may be over, in terms of setting the agenda, for the wing of Toryism that brought him to Downing Street. A more constructive relationship with the EU and a more robust management of the fiscal outlook would help confidence in UK assets. A stronger pound and better returns from UK equities could result. However, we need to get through a Tory party leadership election first…it will fill the entertainment gap between the end of Wimbledon and the start of the Premier League season at least!
Politicians that hold high office in social democratic systems tend to be quite short duration. A typical term in office runs about four or five years and either by the design of the system or because of electorates getting fed up, it is very rare that any individual’s mandate goes on for more than two terms in office. Most don’t make that. Many don’t make even a full term. Unsurprisingly, Boris Johnson is one of them. The coalescing of opposition to him remaining as British Prime Minister amongst members of his own political party brought about scenes of drama in Westminster this week. While Mr. Johnson himself remains reluctant to step down immediately, there is no doubt that the UK will have a new Prime Minister and a new cabinet by the time the clocks go back this autumn. It could even be sooner. Investors, of course, need to look through these short term political dramas and focus on what underlying economic issues both contribute to political uncertainty and need addressing when there is more political purpose.
The events of the week reflect a lot on Boris himself and his style of “leadership”. But the political forces go deeper than just the individual. The ruling Conservative Party was itself split on whether to pursue Brexit in the first place back in 2016 (recall that the then Prime Minister, David Cameron, campaigned to remain). The party was further divided in the wake of the referendum when Cameron’s successor, Theresa May, tried to come up with a less harsh Brexit than the one which was eventually signed off once Johnson, with the considerable support of the Brexit arm of the party, was able to topple Mrs. May. This summer is likely to see those divisions again in plain sight.
There is no majority appetite in parliament, across parties, for the UK to seek re-entry to the European Union (although opinion polls suggest that the public divisions on membership haven’t changed much since 2016 – i.e. roughly 50:50). But that does not mean the status quo will prevail. A more moderate Conservative government – under what would need to be a very different leader and populated by a very different squad to that which has been running ministries for the last couple of years – could address some of the Brexit related issues that have had negative economic effects since 2018. It is clear that trading with the EU has become more difficult for UK firms, particularly in the SME sector, and trade is far from frictionless as the long-queues of lorries at the Port of Dover suggest. There is also the logjam over the Northern Ireland protocol. Shortages of workers in hospitality and agriculture are also very visible effects of the end of freedom of movement. Some of these issues could be addressed by a new government. The rejoicing in Brussels over the news of Johnson’s demise hints at a willingness of the EU to also seek a more constructive relationship.
Fiscal stability needs to be addressed
Progress on relations with the EU would be welcomed. The modest strengthening of sterling in the FX markets suggests that markets would respond positively to a change in direction in UK policy. More broadly, because of COVID, UK fiscal policy has been very reactive in recent years. The government was generous in providing help during the pandemic and has been panicked into providing some relief from higher energy bills. But there has hardly been a well thought out, long-term approach to fiscal policy. The Office for Budget Responsibility recently published a paper addressing the risks to the sustainability of public finances in the UK, citing the impact of COVID, Brexit and the energy crisis. In March the OBR estimated that government borrowing would reach 3.9% of GDP in the current fiscal year. Slower growth and higher interest payments pose upside risks to that estimate. Addressing the deterioration in public finances while balancing the need to fulfil political promises around “levelling up” and supporting the public health system will be a major challenge to Johnson’s successor.
Upside for EU relations?
A more constructive trade agreement with the EU and the ditching of ridiculous (and costly) ideas like re-introducing imperial measurements, could help UK economic performance. Despite the current cycle of monetary tightening, interest rates are likely to remain relatively low. The UK has already made some impressive strides in developing renewable energy and this should support innovation in the clean technology sector. Reversing some of the Brexit related decisions that have led to a decline in international cooperation in scientific research would also be good.
In for a penny…
The UK market is cheap relative to other developed equity markets and the pound is cheap at below $1.20 against the dollar. Global equity investors might be tempted by a cheap equity market and a cheap currency if there is some positive turn in the political direction in the UK. Of course, sentiment towards risky asset remains poor. With our portfolio management teams I just completed the quarterly assessment of the outlook for bonds and equities using our framework that looks at macro, valuation, sentiment and technical factors (MVST). There were pretty consistent negative scores for macro across credit and equities and also pretty consistent positive valuation scores. Cheapening markets today suggest better returns ahead but investors are still searching for the catalyst to turn more positive.
Events, as always, are important. Coming up we will get the next round of US inflation data, another Fed interest rate decisions, the beginnings of the second quarter earnings season and, back to the UK, a potential political reset. There is scope for all of these things to be negative for markets and the depth of division in the UK generally and the Conservative Party in particular means that political events might get even worse. Investors hope that a more pragmatic leadership emerges with a real focus on long-term economic issues for the UK. It’s not a bad economy, there are world leading companies, a robust financial services industry and a well-educated labour force. If politics can unleash the potential, then UK markets can provide many more opportunities for investors going forward.