The recent dramatic events that led to the resignation of British prime minister Boris Johnson on July 7, 2022, raised the issue of how politics – and more specifically, economic policy uncertainty – is affecting the U.K. economy. The answer, of course, is, and sometimes it takes up to two years.
News of Johnson’s resignation has created a minor rally in the sterling, limited by Johnson’s exit prospects after several ministerial resignations in the previous days. The possibility of a recession in the U.K. has likely had more of an impact on the pound lately, but after days of speculation over whether Johnson will step down, a move to the upside in political certainty seems to have boosted the sterling. This certainty will be short-lived, as we now have to wait for the outcome of the Conservative Party leadership contest.
Any significant political change like this will also create uncertainty around economic policy. This can be measured, for example, by watching the discussion of such delays in newspapers alongside surveys of economic forecasters. My recent research with Michael Ellington and Marcin Michalski, also from the University of Liverpool, uses such data from the Economic Policy Uncertainty research project to show that increasing uncertainty about U.K. economic policy can hurt GDP growth for up to 12 months. This could also spill over into U.K. financial markets in the form of long-term borrowing costs of up to 20 months and increased volatility in U.K. bond, currency and equity markets.
Such undesirable developments will continue to cause the U.K. economy to contract unless economic policy uncertainty subsides. The hope now is that the appointment of a new prime minister fairly quickly following Johnson’s resignation will ensure political and financial stability.
But since a quick new appointment is unlikely, it’s worth looking at how exactly and how long uncertainty persists could affect economic indicators such as the pound’s value.
Here are some opinions:
1. Impact of uncertainty on sterling
The pound reflects investors’ confidence in the U.K. economy, and increasing economic uncertainty should push the sterling down. The recent increase in monetary policy delay following the chaotic events surrounding the end of Johnson’s prime ministership is very mild compared to events like the 2016 Brexit referendum or the onset of the COVID pandemic in March 2020.
2. Impact of some certainty on U.K. business investment
Economic policy uncertainty also affects business investment in the U.K., or the number of money investors are prepared to invest in the U.K. economy. Not surprisingly, more significant economic policy uncertainty makes U.K. businesses less willing to invest until the fog of uncertainty clears.
But even when the government of its plans gives some signs, this does not always throw off balance. For example, newly appointed finance minister Nadhim Zahawi wants to stimulate the U.K. economy by increasing the planned corporate tax increase from 19% to 25%. The theory is that shelving the planned expansion will encourage business investment in the U.K., ultimately boosting UK GDP growth.