Editors’ Note: MarketMinder Europe’s political commentary is intentionally nonpartisan, favoring no party nor any politician, assessing developments solely for their potential market and economic effects.
The UK has a new prime minister, and commentators we follow around the globe are predictably focussing on a top politician’s personality and all manner of sociological issues. We will leave that to them, as we think stocks focus much more on actual policy. And on that front, we see plenty of room for the reality of new Prime Minister Liz Truss’s administration to deliver positive surprise. Several commentators we follow have argued that Truss’s economic policies amount to even faster inflation, potentially followed by a debt crisis, which a politicised Bank of England will be unable to fix.[i] We mostly see a new prime minister with a big agenda that is about to run into political gridlock. In other words, the status quo, which we think is likely to bring falling uncertainty and a positive surprise for stock markets.
At first blush, Truss seems to be making a break with the policies of her predecessor, Boris Johnson, and Rishi Sunak—Johnson’s Chancellor of the Exchequer and Truss’s leadership rival. After all, Johnson and Sunak raised the National Insurance Contribution, an unusual stroke for Conservative Party leaders—as was their decision to schedule a corporate tax increase for 2023.[ii] Truss has pledged to undo both and hewed rather closely to traditional Conservative policies on the campaign trail.[iii] But look beyond the past two years, and we think the picture changes. To us, Truss mostly channels Johnson’s economic policy rhetoric pre-COVID, when he and Sunak talked of boosting economic competitiveness and tackling the alleged regulatory and administrative bloat that arose from decades of EU membership. Johnson and Sunak don’t seem to have acted on this much, which many commentators we follow portrayed as a break with the Conservative Party’s 2019 election manifesto. Between her policy brief and cabinet appointments, Truss seems to be posturing her premiership as a return to those election commitments, which we reckon is hardly a radical or unprecedented move from markets’ perspective.
The real question, in our view, is whether she will have any more success than Johnson did at pushing tax cuts and a red-tape bonfire through Parliament. On Thursday, she will reportedly announce her plans to address spiraling energy costs, and those plans are set to include a two-year price freeze paid for with over £100 billion in new debt.[iv] The Conservative Party still has a very strong, very vocal contingent of deficit hawks, and they may be loath to bless what many commentators we follow are calling populist, inflationary tax cuts at a time borrowing is set to soar. That also presumes her energy package is guaranteed to pass as presented to Parliament, which we think is another big if. BBC News reports Truss will propose capping household energy costs at £2,500 annually and similarly freeze businesses’ energy costs, with the government making up the difference between what energy suppliers can legally charge and wholesale power prices.[v] In other words, as we interpret it, the government would send tens of billions of pounds to power providers, basically deferring higher energy costs today to taxpayers tomorrow. At a time when many in the party portray prior years’ COVID relief measures as huge contributors to inflation, a similarly sized spending boost may not go down well.
In our view, intraparty gridlock will likely lead to Truss’s other major policy initiative ending up much milder than many commentators we follow anticipate: Bank of England reform. In her campaign for the Conservative Party’s leadership race, Truss pledged to launch a formal review of the BoE’s performance, mandate and structure, leading to a lot of talk about the end of the bank’s independence.[vi] Most of this is just talk at the moment, and in our experience, reviews like this tend to drag on and don’t always translate to sweeping policy recommendations, much less actual changes. But on the outside chance that Truss did try to push through legislation giving the Treasury more influence on monetary policy, the party’s less populist wings—which, based on our observation, tend to subscribe more to global economic orthodoxy—seemingly have enough clout to quash it. Now, we still think the review overall is probably going to be a mild headwind for stocks if it goes forward, if only because our research shows regulatory uncertainty tends to cast a fog over markets, but we doubt the outcome is anywhere near as disastrous as commentators we follow argue today.
In short, we think the portrayal of the Truss administration as sure to pour lighter fluid on inflation and debt with more spending and lower taxes is overstated. One, gridlock probably waters a lot of these proposals down. Two, we think the link between fiscal policy and inflation is less direct than many presume, as it doesn’t increase the money supply and isn’t assured to speed up spending and lending overall. So whilst fiscal policy could influence inflation, we see it as a mistake to assume it necessarily will. As for debt concerns, our views haven’t changed since addressing the topic in depth last week.
So overall, we see ample room for reality to beat expectations. We think British stock and bond markets alike have spent the summer pricing in expectations for a populist administration to throw piles of cash at inflation and make the problem worse whilst, based on the BoE’s forecasts, a deep recession rages.[vii] Extending the status quo of gridlock, some economic soft patches and inflation that doesn’t skyrocket into perpetuity would likely qualify as relief, which would be fine enough for stocks, in our view. When expectations are at rock-bottom, things generally don’t need to go objectively well for markets to recover—not as bad as feared usually fits the bill, and we see a high likelihood of that happening this time.
[i] “UK Facing 1970s-Style Balance of Payments Crisis Under Liz Truss,” Graeme Wearden, The Guardian, 5/9/2022. Inflation is broadly rising prices across the economy.
[ii] “National Insurance: Boris Johnson and Rishi Sunak Confirm Rise From April,” George Bowden, BBC News, 30/1/2022.
[iii] “What Policies Will Liz Truss Pursue as Britain’s New Prime Minister?” Peter Walker, The Guardian, 5/9/2022.
[iv] “Liz Truss Set to Cut Energy Bills for Millions,” Simon Jack, BBC News, 6/9/2022.
[vi] “Boris Johnson’s Likely Successor Wants to Review the Bank of England’s Mandate. And Some are Worried,” Hannah Ward-Glenton, CNBC, 31/8/2022.
[vii] Source: FactSet, as of 7/9/2022. MSCI United Kingdom Investible Market Index (IMI) and ICE BofA Sterling Broad Market Index total return, 6/6/2022 – 7/9/2022. Pricing in refers to stocks incorporating these expectations into their share prices.
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