investment insights
Boris Johnson and beyond: assessing the UK’s prospects
Lombard Odier Private Bank
Key takeaways
- A weakened Boris Johnson clings on to power; even if the Prime Minister faces a leadership challenge, his successors are unlikely to pursue a radically different policy path
- The UK’s cost of living crisis looks set to worsen in April, and the country has yet to grapple with a post-Brexit hit to productivity. Yet after a deep recession, the economy is in recovery mode and the labour market is in good shape
- Bank of England rate hikes could help sterling gain ground against the euro, at least in the first half of the year; against the dollar we think it could be due a setback
- We continue to like UK stocks, with the FTSE100 weighted towards value sectors that we favour, and scope for a persistent valuation discount to narrow.
As a weakened Boris Johnson seeks to weather a damaging report into Downing Street parties, the country is grappling with a cost of living crisis and the ongoing impact of Brexit. Yet for all the problems it faces, the UK economy is on a recovery trajectory and still offers some interesting investment opportunities.
Do the normal rules of gravity apply to Boris Johnson? Stuck hanging on a zip wire above the Olympic Park in 2012 it seemed so; these days it is harder to tell. The UK Prime Minister put on a brave face over the publication of a long-awaited – albeit shortened – report into Downing Street parties on 31 January; the outcome of a police investigation is still pending. Accusations, scandal and government enquiries piled up in January. Conservative whips stand accused of blackmailing rebel MPs to toe the line. A Muslim Tory MP says she was sacked as a minister in part because of her faith. These allegations may be untrue, but the slow drip of ‘Partygate’ could prove a tipping point for Boris Johnson’s leadership. The publication of the full report, and the result of the police investigation, could be further catalysts. The possibility of 54 MPs expressing no confidence in him, which could happen at any time, is another.
For now, Mr Johnson is weathering the storm. He will hope that the public prefers consistent leadership amid the Ukraine stand-off, and that Tory MPs will reflect on the 80-seat majority he delivered for them in 2019, and his usual trademark ability to speak to voters – particularly those who do not usually vote Conservative. But his credibility, confidence and energy have been weakened. Rebellions within his own party will likely proliferate. The rapid removal of Covid restrictions, a possible U-turn on mandatory vaccinations for NHS workers and attempts to fast-track a “Brexit Freedoms Bill”, hastening post-Brexit deregulation, can be seen as attempts to pacify MPs on the Party’s right, and curry public favour. Yet parliamentary time is increasingly being taken up with internal politics and fractious debates. Progress on key issues – such as tackling poverty, grappling with the renewable energy challenge, and stemming perilous migrant journeys across the English Channel – has stalled.
Trust issues
Trust in government has also waned in the wake of recent scandals, with potential implications from voting patterns, to compliance with wider rules and regulations. Recent opinion polls show a widening majority for opposition Labour, which could prove a challenge for the Conservatives come May’s local elections. And there are tentative signs that the mood both inside the Conservative party and among its voter base may be turning. Having fallen from his pedestal as the most popular Tory leader since Margaret Thatcher, half of Conservative voters now think he is doing a bad job as Prime Minister. A bad outcome in May’s ballots could see the Conservative Party review its options.
Succession issues
When mulling Mr Johnson’s future, one of the issues that may give Conservative MPs pause is the lack of an obvious successor. After securing the biggest Tory majority since the 1980s, many – including Mr Johnson himself – thought he would be in post for years. In the absence of a leadership challenge, no candidates have yet declared their hand, but Chancellor Rishi Sunak is the bookmakers’ favourite to succeed him, with Foreign Secretary Liz Truss second, and Housing Secretary Michael Gove, Health Secretary Sajid Javid and Jeremy Hunt also in the running. The most charismatic and voter-friendly is surely Rishi Sunak, whose swift implementation of the furlough scheme early in the pandemic helped protect jobs and earnings. But there is no indication that a new leader would bring any real change of policy, beyond trying to restore public trust.
Economy and Brexit pose challenges
The two frontrunners are also responsible for tackling Britain’s biggest challenges: the economy and Brexit. The UK’s cost of living crisis looks set to escalate in April as energy bills rise up to 50% and new taxes bite, testing public patience further. Workers are already earning lower real pay, on average, than before the global financial crisis. December’s 5.4% inflation figure is more than double the bank of England's 2% target, and is not expected to mark the peak. Britain’s open economy remains vulnerable to problems in global supply chains. These are unwinding, but could remain knotty in 2022, especially if Omicron prompts further lockdowns at Chinese ports or factories. Meanwhile, with oil trading over USD80 per barrel, prices at the petrol pump remain high and rail fares will rise in spring too. Would voters still warm to a fresh-faced Mr Sunak even in the face of swingeing new taxes and inflation at a 30-year high?
The other leading Tory candidate, Liz Truss, has assumed the poisoned chalice of negotiations with Brussels over the Northern Ireland protocol, implementing the Brexit deal and healing diplomatic rifts. Although Ms Truss has a more conciliatory reputation than her predecessor Lord Frost, the threat of triggering Article 16, an economic hand grenade for the UK, still hangs over the talks. Northern Ireland elections in May promise further frictions. After years of growth, business investment in the UK has been flat since the 2016 Brexit vote. Trade with the EU has slumped since the UK left the single market and customs union. Food and drink exports have fallen by a quarter since Brexit, the industry estimates. EU countries largely returned to pre-Covid trade levels by Q3 2021, but UK trade flows were the lowest relative to GDP in over a decade. From July 2022, stricter goods checks will begin. Longer-term, the Office for Budget Responsibility estimates total UK imports and exports will be 15% lower than if it had stayed in the EU, with a 4% hit to the economy’s long-run productivity.
Vaccines, the City and jobs
For all that, the UK’s economic prospects are far from bleak. It has signed around 70 post-Brexit trade deals and agreements, many rolling over existing arrangements. Deregulation could unleash more gains. The City of London has proved resilient thus far in the face of Brexit challenges; the UK remains Europe’s leading biotech hub and a leader in creative industry exports such as film and TV. After one of the deepest pandemic recessions among major economies, the UK’s recovery is now among the fastest-paced. We believe growth could top 5% this year. The Omicron wave has peaked and restrictions have been removed, amid an impressive vaccine booster campaign. Pent-up demand in services could now be unleashed: indeed, while it dipped in January amid Omicron restrictions, the IHS services Purchasing Managers Index came in higher than expected, and still showed solid expansion. The government’s fiscal stance will continue to support growth, only tightening gradually in coming years. Meanwhile, the labour market remains in surprisingly good shape despite the pandemic: unemployment fell further in December, two months after the furlough scheme ended, to reach 4.1%, versus a 3.8% pre-pandemic low.
Where now for stocks and sterling?
Labour market resilience was a factor behind the first Bank of England rate increase in December, to counter stubbornly high inflation. Markets are pencilling in four more hikes in 2022, bringing the headline rate to 1.25% by year-end (we think three could be more realistic). We expect the first this week, to bring the base rate to 0.50%. The Bank has previously said it will start trimming its balance sheet with rates at this level, likely by not investing the proceeds of maturing bonds. Expectations of monetary easing ahead have helped bolster sterling, which has gained ground from mid-December lows against both the dollar and the euro. We believe strong monetary policy divergence with Europe could help sterling against the euro in the coming months, but that the pound’s valuation looks stretched against the dollar at current levels. We maintain our forecast of GBPUSD closer to 1.30.
The FTSE also started the year well, before falling – in line with global indices – over the past 10 days. The UK remains among the cheapest of global equity markets. Our 1.5% UK equities overweight across client portfolios reflects expectations this valuation discount will narrow. UK stocks saw big outflows in 2016 after the Brexit vote, which have struggled to return, but there are signs this may be starting to change. Many of the FTSE’s global mining, pharmaceutical and consumer goods firms make most of their revenues outside the UK’s borders. The index also has a higher weighting towards value than growth stocks, including sectors such as energy, materials and healthcare that we favour in a rising rate environment. Looked at in this context, the fate of a single politician is of secondary importance.
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