Boris Johnson was ultimately forced to resign as UK prime minister Thursday as dozens of members of his party quit the government after one ethics scandal too many.
But his popularity outside parliament has also been badly dented by surging inflation and stagnation in the British economy, a cost-of-living crisis that threatens to impoverish millions more people this winter, and the risk of a damaging trade war with the European Union.
UK stocks rose in response to reports that Johnson was preparing to stand down, and the pound gained 0.75% to trade at $1.20 — recovering slightly from two-year lows hit earlier this week.
“Make no mistake however, the [pound] remains severely weak due to the dire state of the UK economy which is underperforming its peers, [and] likely to enter into a recession,” wrote Walid Koudmani, chief market analyst at broker XTB, in a note to clients.
Whoever emerges from the rubble of his administration as new leader of the Conservative Party and the country, they face a series of extraordinary economic and financial challenges.
The UK has the highest inflation in the G7…
Every major economy has suffered from the pandemic’s lingering effects on supply chains, and the shock to energy and food costs delivered by Russia’s invasion of Ukraine in February.
But the United Kingdom has it worse than most of its peers. Inflation hit a 40-year high of 9.1% in May, the highest among the G7 leading economies — and is forecast to climb above 11% later this year despite a series of interest rate hikes.
The knock-on effects of Brexit — Johnson’s signature achievement in government — have exacerbated crippling labor shortages and increased operating costs for businesses. The cost of imports has also been driven higher by a sharp fall in the value of the pound this year.
The rise in food and fuel prices has created the worst cost-of-living crisis in decades, forcing lower-income households to choose between “heating and eating,” a rallying cry for anti-poverty campaigners as they demand more government support.
Johnson’s government promised £400 ($502) in grants per family to help out the millions of people struggling to pay their energy bills. It also bowed to pressure last month and unveiled a £5 billion ($6.3 billion) tax on the windfall profits of oil and gas companies.
But those efforts are being swallowed up. Disposable incomes are on track for the second biggest fall since records began in 1964, according to the Bank of England, driven by the soaring cost of energy and food. And those bills are about to get a lot worse.
Annual average household energy bills could rise by about 50% to £3,000 ($3,600) this winter when a cap on the maximum price suppliers can charge customers is revised in the fall. The regulator already raised the cap by a whopping 54% in April.
British households have been left particularly exposed by a persistent decline in living standards. Typical wages are no higher today than they were before the 2008 financial crisis, the Resolution Foundation said on Monday.
“Britain’s poor recent record on living standards — notably the complete collapse of income growth for poor households over the past 20 years — must be turned around in the decade ahead,” said Adam Corlett, principal economist at the foundation.
And is heading for the lowest growth…
Without stronger growth, that pay slump won’t be reversed. And there’s little prospect of that any time soon. Around the world, once-robust recoveries are being dragged down. But the United Kingdom is in a particularly bad spot, with a recession looming.
The world’s fifth-biggest economy ground to a halt in February and started shrinking in March. The decline accelerated in April, when GDP is estimated to have fallen by 0.3%, with all three major sectors of the economy — services, manufacturing and construction — going backwards, according to the Office for National Statistics. Retail sales fell in May for the second consecutive month.
There’s more bad news ahead. In a report on financial stability published earlier this week, the Bank of England said that the outlook for the UK economy had “deteriorated materially.”
The Paris-based Organisation for Economic Co-operation and Development forecast last month that the UK economy was heading to stagnation, with zero growth in GDP forecast for 2023. That would be the worst performance in the G7 next year.
Weak growth is bad news for government debt, which has shot up to more than 90% of GDP as a result of measures taken to help businesses and households cope with the pandemic and the energy crisis.
Throw in the pressures of an aging population and UK public debt is on “an unsustainable path and projected to surpass 250% of GDP over the long term,” the government’s fiscal watchdog — the Office for Budget Responsibility (OBR) — said on Friday.
That means there’s little room for the next prime minister to make big tax cuts or spending pledges.
“This all adds up to a challenging outlook for this and future governments as they steer the UK economy and public finances in the years ahead,” the OBR added.
… while Brexit hasn’t delivered
Johnson succeeded where his predecessor, Theresa May, failed by “getting Brexit done.” But the break with the European Union hasn’t delivered the boost to trade that he and other Brexit advocates promised.
The United Kingdom missed out on much of the recovery in global trade since the pandemic, the OBR concluded in March.
For many businesses, the tariff-free trade deal Johnson signed with EU leaders less than two years ago has caused a huge increase in customs paperwork, making it harder for them to sell to their biggest export market and increasing the cost of imports. And deals signed with other countries barely move the needle.
“While additional trade with other counties could offset some of the decline in trade with the EU, none of the agreements concluded to date are of a sufficient scale to have a material impact on our forecast,” the OBR stated.
Official data published last week showed the UK balance of payments deficit soared to 8.3% of GDP in the first quarter of 2022, meaning the country is having to rely ever more heavily on foreign investment to make up for the fact that the country is importing far more than it exports.
Against that backdrop, the pound has been hammered this year, not helped by Johnson’s threat to tear up part of the Brexit treaty he signed. That has poisoned relations with EU leaders, and brought talk of retaliation that could escalate to a trade war that would likely hurt the United Kingdom the most.
“Judging by the early line-up of potential successors to Johnson, the balance of potential outcomes would tilt towards less strained relations with the EU,” noted Kallum Pickering at Berenberg.
“Even the ardent Brexiteer candidates … are less of the populist variety than Johnson. This suggests that, while it is unclear whether UK-EU relations would improve a bit or a lot, the overall situation stands to be much calmer.”
