Former chancellor Rishi Sunak looks set to become the UK’s third prime minister of 2022 after Boris Johnson announced he would not stand in the Conservative leadership election.
Leader of the house of commons Penny Mordaunt has until 2pm this afternoon to secure the backing of 100 MPs and force the leadership contest to go to a vote of the party membership, after Sunak secured enough backers to reach the threshold over the weekend.
At the time of writing, Mordaunt is rumoured to have roughly 90 supporters.
The pound rose against the dollar at the start of the day’s trading, after the prospect of further political instability caused by a return to No 10 for Johnson was taken off the table.
Richard Hunter, head of markets at Interactive Investor, said: “For the UK, sterling found some support as the political drama continued to play out, with Rishi Sunak now being touted as the strongest prime ministerial candidate.
“The current level of sterling of over $1.13 is a comfortable improvement to the level of £1.03 which it had briefly touched, but a rampant US dollar this year has eroded the price of the year’s opening level of $1.35. In spite of the possibility of some political stability being restored, the UK economy remains in a potentially dark place, and the FTSE 250 has served as a barometer with a drop of 26% this year.”
Calmer political horizon ahead
Commenting on market movements following the latest twist in the race to succeed Liz Truss, Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: “The cult of Boris, which was hanging over the Conservatives like a charm of enchantment, has for now been broken, sending the pound higher, after the former prime minister said he would not stand again. Westminster is rife with speculation that he had not garnered enough support from MPs, despite his protestation of the contrary.
“He had threatened to cause fresh political instability, given that it’s less than two months since he left the job, so his retreat from the race brought a sigh of relief for sterling and an even bigger sigh of relief on the bond markets. The pound is up by more than 0.6% to $1.136 with former chancellor Rishi Sunak now favourite to take the top job.
“There is a growing chance that Penny Mordaunt could also secure the backing of 100 MPs, the threshold needed to keep her in the running, the outcome of which could still be decided by party members. Given her popularity among grass roots Conservatives we could see a groundhog day scenario emerging where the party faithful elect the candidate less popular with MPs, which could add to the clamour for an early general election.
“But with Liz Truss out of the job and Boris Johnson out of the running it’s been enough to help push down UK borrowing costs. Ten-year gilt yields have fallen back sharply from above 4% on Friday to 3.8% in early trading. It’s an indication that bond vigilantes have been pacified by the expectations of a calmer political horizon ahead with fiscal responsibility forecast to be the new mantra of the incoming prime minister.
“Whoever clinches the leadership faces a daunting task given the looming recession, volatile energy prices, continued supply chain tangles and labour shortfalls and a Bank of England determined to raise interest rates in the face of a shuddering economy to bring rampant inflation under control.”
International investors looking for actions to restore UK’s credibility
Following short-lived chancellor Kwasi Kwarteng’s mini budget on 23 September, the pound fell to a record low against the dollar, while gilt markets crashed as investors lost confidence in the UK economy.
Although most of the measures announced by Kwarteng were promptly abolished by his successor Jeremy Hunt, the nation’s economic credibility has been damaged by the events of the past few months, according to Carmignac fixed income analyst Michael Michaelides.
“The appointment of a new prime minister should see the political drama settle, but this cannot disguise how the UK looks to international investors. For us, it’s not so much who is in Downing Street that matters but what they do.
“Until the mini budget, the UK was perceived as having a best-in-class fiscal framework under the Office of Budget Responsibility (OBR). Its reports are closely scrutinised, and international investors trust its role in monitoring the UK’s fiscal rules.
“This was a key reason that investors did not penalise the UK’s slower budget consolidation after the financial crisis and funded its persistent budget and current account deficits. Even now the UK’s ‘structural’ deficit is higher than any of its G7 peers, bar the US. The US issues the world’s reserve currency, the UK does not. That is the whole point of credibility: it must be painstakingly built up but can be quickly squandered.
“To regain credibility, at a minimum, the government must undo the three most damaging moves: exposing the public purse to the full potential upside costs of international gas prices, planning more than £250bn of tax cuts announced over the next five years and avoiding the OBR’s scrutiny. Announcements so far have not made up all the lost ground.
“The government need not abolish the remaining help on gas prices, nor even the remaining tax cuts. However, these need to be fully costed, with a plan to pay for these in a rapid time frame. The government urgently needs to announce and meet new fiscal rules that close the structural budget deficit. This requires a combination of tax rises, fewer tax cuts, and politically realistic spending restraint.
“This is the cost of inviting scrutiny: investors cannot now ‘unsee’ the underlying metrics. This is the cause of the risk premia attached to UK borrowing rates for the government, corporates, and households. Even full reversal may not be enough, more may be needed, but for now it is the bare minimum.”