The Rise and Fall of UK Political Uncertainty in 2022

Editors’ Note: MarketMinder Europe favours no political party nor any politician. We assess political developments for their potential economic and market impact only.

As 2022 dawns, we see no shortage of political theatre—and no shortage of uncertainty. Some of it is electoral, with national contests looming in France and Australia and Americans voting in Congressional elections in November. Some relates to shaky coalition building, which may soon be reality in Italy if Prime Minister Mario Draghi gets tapped as president later this month. And some is just good old fashioned scandal and parliamentary revolt, which happens to be the situation in the UK. Yes, Prime Minister (PM) Boris Johnson is—once again—facing calls to resign over some Downing Street socialising during 2020’s lockdowns. We have even seen speculation from some commentators we follow that a police investigation could lead to formal charges for violating lockdown rules. We won’t hazard a guess on whether Johnson’s days in office are numbered, but we do think this is a textbook example of how high uncertainty early in the year is likely to fade gradually into political gridlock—which we see as a likely tailwind for stock markets later this year.

Leaked reports of Downing Street gatherings occurring during lockdowns have stalked Johnson for over a month now, but the situation has escalated this week thanks to a leaked email from one of his senior aides inviting over 100 staffers to “make the most of the lovely weather” and “bring your own booze” on 20 May 2020, a time when normal people weren’t allowed to gather in groups larger than two—even outdoors.^[i] As you might expect, people on social media are now posting videos of police breaking up gatherings the same day, along with pictures of dying relatives they weren’t allowed to visit. Labour leader Keir Starmer (who was once photographed having an indoor tipple with Labour staffers when indoor gatherings were off limits) is urging Johnson to resign, which we don’t think is earth shattering—but Scottish Conservative leader Doug Ross is also calling for his head.^[ii] So, from what we have seen, are several backbench Members of Parliament (MPs), a broad swath of the public and some Conservative-leaning columnists.

Yet so far, he appears to be hanging on—probably in no small part due to the cabinet’s continued support. That group includes Chancellor of the Exchequer Rishi Sunak and Foreign Secretary Liz Truss, widely seen amongst political commentators we follow as the top two potential leadership challengers. The support of these senior Tory figures suggests to us they don’t yet see now as an optimal time for a challenge. But this may change, pending an official investigation by Sue Gray, a senior civil servant whose CV includes the position of Director-General of Propriety and Ethics in the Cabinet Office.^[iii]

If Johnson survives this bout, he likely isn’t in the clear, as a significant hurdle looms: a triple whammy of tax changes that, combined with ongoing inflation and the pending reset of the Energy Price Cap, many commentators we follow have termed a cost of living crisis. This April, barring a late change, the increased National Insurance Contribution (NIC) takes effect, and value-added tax (VAT) relief on food and drink will end, bringing VAT back from 12.5% to 20%.^[iv] Income tax bands also start a five-year freeze in April, even as inflation erodes a big chunk (if not all) of many households’ nominal wage increases.^[v] This means thousands of households will likely land in higher tax brackets thanks to inflation alone, adding to their burden. Now—and this isn’t a political statement—we don’t think this is likely to be a huge negative for stocks, as we think markets don’t think in terms of good or bad in the absolute sense. Rather, our research shows that what matters is the degree to which any development packs negative surprise power. In this case, added household costs are widely known, having been on the calendar for months. The amounts in question likely also aren’t huge from stocks’ vantage point, even though we agree they are negative for individual households—particularly lower-income households. We just have also found that markets behave like cold-hearted, rational beasts.

But we do see a very good chance that, as households’ costs rise, voters’ frustration with Johnson grows, particularly considering the NIC hikes violated his campaign manifesto. This is also starting to split the cabinet, with some high-profile members reportedly urging Johnson to cancel the tax increases to give households some relief. The more scandals weaken his political capital, the louder those calls probably get. Even if they don’t lead to actual tax relief, we suspect they could finally foment the cabinet revolt many observers we follow think is likely this year.

However this resolves, we see a high likelihood that uncertainty stays elevated through the winter and early spring, then dies down once people have clarity on who will be in charge. Whether that person is Johnson, Sunak, Truss or someone else, it likely leads to more political gridlock, as their main task will probably be to rebuild popular support for the party before the next election, due by 2024. In our view, that creates a strong incentive not to rock the boat with big legislation. If Johnson remains PM, his political capital may also be so depleted that his ability to push divisive legislation will be sapped.