Boris Johnson was forced to resign as UK prime minister on Thursday after dozens of members of his party quit the government following one too many ethics scandals.
However, his popularity outside of parliament has been severely harmed by the British economy’s surging inflation and stagnation, a cost-of-living crisis that threatens to impoverish millions more people this winter, and the threat of a damaging trade war with the European Union.
Following reports that Johnson was preparing to resign, UK stocks rose, and the pound rose 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.
Regardless of who emerges from the ruins of his administration as the new leader of the Conservative Party and the country, they will face a slew 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, as well as the energy and food price shock delivered by Russia’s February invasion of Ukraine.
However, the United Kingdom fared worse than most of its peers. Despite a series of interest rate hikes, inflation hit a 40-year high of 9.1 percent in May, the highest among the G7 leading economies, and is expected to rise above 11 percent later this year.
The consequences of Brexit, Johnson’s signature achievement in government, have exacerbated crippling labor shortages and increased business operating costs. The cost of imports has also risen as a result of this year’s sharp drop in the value of the pound.
Food and fuel price increases have 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 demanding more government assistance.
Johnson’s administration promised £400 ($502) grants per family to assist millions of people who are struggling to pay their energy bills. It also bowed to pressure last month, announcing a £5 billion ($6.3 billion) tax on oil and gas companies’ windfall profits.
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.
The persistent decline in living standards has left British households particularly vulnerable. According to the Resolution Foundation, typical wages are no higher today than they were before the 2008 financial crisis.
“Britain’s poor recent record on living standards, particularly the complete collapse of income growth for poor households over the last 20 years,” said Adam Corlett, principal economist at the foundation.
And is heading for the lowest growth.
That pay slump will not be reversed without stronger growth. And there’s little chance of that happening anytime soon. Previously robust recoveries are being dragged down all over the world. However, the United Kingdom is in a particularly bad situation, with a recession on the horizon.
The world’s fifth-largest economy came to a halt in February and began contracting in March. According to the Office for National Statistics, the decline accelerated in April, when GDP was estimated to have fallen by 0.3 percent, with all three major sectors of the economy — services, manufacturing, and construction — declining. Retail sales fell for the second month in a row in May.
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.
Add to that the pressures of an aging population and the UK public debt is on “an unsustainable path and projected to exceed 250 percent of GDP over the long term,” according to the government’s fiscal watchdog, the Office for Budget Responsibility (OBR), on Friday.
That leaves little room for the next prime minister to make major tax cuts or spending pledges.
“All of this 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
By “getting Brexit done,” Johnson succeeded where his predecessor, Theresa May, failed. However, the break with the European Union has not resulted in the trade boost that he and other Brexit supporters promised.
According to the OBR, the UK missed out on much of the global trade recovery since the pandemic.
For many businesses, the tariff-free trade agreement Johnson signed with EU leaders less than two years ago has resulted in a massive increase in customs paperwork, making it more difficult to sell to their largest export market and rising import costs. And agreements with other countries make little difference.
“While additional trade with other counties could offset some of the declines 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.
According to official data released last week, the UK balance of payments deficit increased to 8.3 percent of GDP in the first quarter of 2022, implying that the country will need to rely on foreign investment to compensate for the fact that it imports far more than it exports.
Against that backdrop, the pound has suffered this year, exacerbated by Johnson’s threat to rip up a portion of the Brexit treaty he signed. This has tainted relations with EU leaders and fueled talk of retaliation, which could lead to a trade war that would disproportionately harm the United Kingdom.
“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.”