LONDON — U.K. Prime Minister Boris Johnson’s eventual successor is likely to bring forth greater fiscal support and a less fractious relations with the European Union, according to economists.
Johnson formally resigned as leader of the Conservative Party on Thursday, but said he would stay in Downing Street until a successor is chosen — despite many calling for him to step aside immediately and allow a less controversial “caretaker” to take over in the interim.
Exactly when a new leader will be appointed is unclear, but reports suggest the aim is to have one confirmed before the Conservative Party conference in October. By Monday morning, 11 hopefuls had entered the race to replace Johnson with Rishi Sunak, Penny Mordaunt and Liz Truss the favorites, according to the U.K. bookmakers.
The prime minister’s ousting coincides with a particularly perilous period for the U.K. economy. Inflation hit a new 40-year high of 9.1% in May as soaring food and energy costs deepened the country’s cost of living crisis.
Meanwhile the economy unexpectedly shrank in April to mark the first consecutive GDP contractions since the start of the Covid-19 pandemic — and the U.K. is widely tipped to experience a technical recession in the second half of the year.
The Office for Budget Responsibility, the U.K.’s independent fiscal body, has projected that real disposable incomes will fall by 2.2% this financial year (2022/2023), the largest annual decline since records began, as the squeeze in household spending power persists.
“Additionally, the uncertainty around the duration and outcome of the conflict in Ukraine is likely to adversely affect investments, as well as export performance via secondary effects on the growth outlook for the EU, the U.K.’s key trading partner,” said Boris Glass, senior U.K. economist at S&P Global Ratings.
“Given the aforementioned inflation squeeze, the Bank of England‘s (BOE’s) tightening of monetary policy, and no end in sight to the Russia-Ukraine conflict, we project 1% growth for the U.K. for 2023, the lowest rate among G-7 countries.”
Former Finance Minister Rishi Sunak, whose resignation was one of two which triggered the eventual end of Johnson’s tenure, announced a series of measures over the last six months in an effort to combat the cost of living crisis, including a windfall tax on oil and gas majors and a one-off payment to 8 million of the lowest income households.
However, economists broadly expect whichever candidate takes the reins from Johnson to up the ante on fiscal support for the ailing economy.
Modupe Adegbembo, G-7 economist at AXA Investment Management, said a key question is whether Johnson uses his “caretaker” period as prime minister — should he be granted one — to push through short-term fiscal policies.
“However, when a new Prime Minister is appointed, we see an increased likelihood of additional fiscal spending and/or tax cuts,” Adegbembo said in a note Thursday.
“The potential to accelerate income tax cuts penciled in for 2024 may be floated by some candidates, although remains challenging in the light of public finance developments.”
Her comments were echoed by strategists at UBS, who said a change in leadership makes further fiscal support more likely as a new prime minister will “want to prove themselves.”
“Any additional support for the U.K. economy would come at an opportune moment: The GDP growth estimate for March was –0.1% compared to February, and for April it was –0.3% versus March,” UBS CIO Mark Haefele’s team said in a note Friday.
“Another increase to the energy price cap means there is further pressure ahead, but while our base case is that the U.K. will narrowly escape recession, it is important to remember that the FTSE 100 generates just 25% of its revenues inside the U.K.”
As such, U.K. large cap stocks are not particularly sensitive to domestic economic growth, and benefit from weakness of the pound; many FTSE 100 companies make profits in dollars which are therefore strengthened when the pound weakens against the greenback.
Strategists at asset manager Invesco agreed, highlighting that as long as sterling remains weak, investors may have opportunities to pick up “high-quality, international companies at a double discount.”
Sterling rose fractionally after Johnson’s resignation but gave back those gains and then some on Friday as global pressures continued to weigh on the pound. The FTSE 100 has remained largely impervious to the political turmoil, tracking gains across Europe.
UBS also noted that high exposure to both commodity-linked and “value” sectors – stocks which typically trade at a discount relative to their fundamentals – has supported the U.K. market of late and rendered it one of the Swiss bank’s preferred equity markets.
“The immediate outlook is likely to hinge on whether Johnson manages to stay on for the next two months – in which case markets risk a period of additional volatility going into the summer,” AXA IM’s Adegbembo said.
“However, if Johnson were replaced by another ‘caretaker’, the prospect of domestic policymaking would fall, something which should reduce any expected volatility.”
The Brexit problem
No clear frontrunner has emerged to take over as leader of the Conservatives, with the field likely to be crowded and diverse. However, even once a new prime minister moves into Downing Street, the approval of any fiscal package to help consumers is not a foregone conclusion.
Invesco suggested that this uncertainty means the U.K. economy will continue to “wither” in the interim, and is most likely among developed economies to experience a recession this year.
Along with the global pressures of supply chain problems and the war in Ukraine, the U.K. is also dealing with the trade and economic fallout from Brexit, which Invesco’s multi-asset team said were fueling the inflationary fire on food and energy bills.
“It’s hard to turn more constructive on the U.K. economy right now. Not only are economic fundamentals weakening, but the profound risk of a policy error is significant,” Invesco strategists said.
“Given the current pressures, we think it’s become even harder for the government to unify around a clear strategy going forward.”
Despite being elected in 2019 on a promise to “Get Brexit Done” and touting his “oven-ready” exit deal with the European Union, Johnson’s government has continued to wrangle with Brussels over the operation of the Northern Ireland protocol, a key tenet of the withdrawal agreement signed by both parties.
S&P Global’s Glass suggested that a new government may try to repair relations with the EU by taking a more conciliatory approach to trade relations, but this outcome is far from guaranteed given the breadth of views within the Conservative Party.
“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,” said Berenberg Senior Economist Kallum Pickering.
“Even the ardent Brexiteer candidates (Penny Mordaunt and Liz Truss) are less of the populist variety than Johnson.”
Cause for long-term optimism?
Over time, less fraught relations with the EU may also prove to be a catalyst for stronger business investment, offering a sustained path higher for sterling towards fair value of 1.40-1.45 against the dollar and 1.20-1.25 against the euro, Pickering suggested.
“Looking further out, a Conservative leadership election followed by a snap election during the new leader’s honeymoon phase is not unthinkable for late-2022 or early-2023. Both Johnson and May took the UK to the polls soon after becoming Conservative leader,” he added.
Beyond the immediate political volatility, however, Glass argued that the U.K. continues to benefit from “strong institutional settings and a credible monetary policy.”
The Bank of England has begun hiking interest rates in a bid to rein in inflation, and S&P Global believes consumer prices will gradually be brought under control by mid-2024.
“Moreover, despite a weakening of the macroeconomic outlook, public finances have been stabilizing overall, with net general government debt projected to fall to 94% of GDP by 2025 from 96% at the end of 2021,” Glass said.
Euro-Zone Economy Grew Less Than Estimated in Second Quarter – BNN Bloomberg
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The euro-area economy grew slightly less than initially estimated in the second quarter as signs continue to emerge that momentum is unraveling.
Output rose 0.6% from the previous three months between April and June, compared with a preliminary reading of 0.7%, Eurostat said Wednesday. Employment, meanwhile, climbed 0.3% during that period.
While the data still suggest Europe’s economy was on a relatively firm footing coming into the summer, analysts worry that energy shortages will drive record inflation higher still, tipping the continent into a recession. A downturn lasting two quarters is now more likely than not, according to a Bloomberg survey, which puts the probability at 60%.
Inflation is expected to average almost 8% in 2022 — about four times the European Central Bank’s goal. Officials have stressed the importance of reacting forcefully to prevent expectations of higher inflation from becoming entrenched, though some economists question how far interest rates can be lifted if there’s a recession.
©2022 Bloomberg L.P.
B.C.’s export economy continues to cash in on its Cascadian connections – Business in Vancouver
It is well known that the United States is British Columbia’s largest export market and number one international commercial partner.
Even if the specific details of export magnitudes are not widely known, most people recognize that being physically adjacent to the world’s largest economy means B.C.’s trade will invariably be tilted to the south. A common language, similar business and legal environments, and previous trade agreements further augment this powerful cross-border trade orientation.
In a typical year, B.C. sends about half of its merchandise exports stateside. In 2021, the share was even higher: 55 per cent. China, a distant second, accounts for 15 to 16 per cent of the province’s international merchandise exports, followed by Japan at around 10 per cent.
Less well known is that the distribution of B.C.’s exports within the U.S. is similarly shaped by geography and the size of the various state economies. In particular, the three West Coast states – Washington, Oregon, and California – collectively absorb 45 to 46 per cent of the province’s U.S.-bound merchandise exports. We estimate that, if services are included, these three states buy more than half of everything the province sells to the giant American market.
When it comes to cross-border trade, geography and size matter – a lot. The I-5 highway, connecting coastal cities from San Diego through California to Portland, Seattle and Vancouver, with arteries extending into northern B.C., has long supported economic activity along the west coast of North America. It has also enabled steady trade growth. The built-up networks of railways, pipelines, electricity transmission lines and seaports and airports – and the sharing of a common time zone – all serve to reinforce the pattern and depth of commerce along the west coast.
Underscoring the point that geography matters, last year B.C. exported $9 billion in goods to next-door Washington state, equal to 30 per cent of U.S.-bound merchandise exports. In fact, exports to Washington state match the value of B.C.’s exports to China, the world’s second largest economy.
The size of the individual state economies is also a key factor shaping cross-border trade. California is the largest economy in the U.S., and one of the biggest in the world. So, it’s not surprising that California ranks as B.C.’s second largest individual state export market, taking nearly 12 per cent of our U.S.-bound goods.
Broadening the picture to include services, California stands out even more, given that it boasts world-class advanced technology and film and entertainment industries. California is also important as a source of international visitors to B.C. When service exports are included, our research suggests that California accounts for about one-fifth of the value of British Columbia’s U.S.- bound exports.
California is unique among the province’s trading partners in that service exports exceed merchandise exports in dollar terms. B.C.’s exports of film and television productions have increased sharply and are now close to $2.5 billion annually; the bulk of this involves business done with California. Also, California accounts for a disproportionate share of B.C.’s exports of scientific, technical and professional services and of technology-based services, and the state is also a leading supplier of international tourists to the province. In total, once tourism activity fully resumes, we project that B.C.’s service exports to California will soon exceed $6 billion, almost twice the value of our merchandise exports to the Golden State.
In sum, international goods exports to B.C.’s three neighbouring coastal states amounted to almost $14 billion in 2021. With some educated guesswork, and assuming tourism fully recovers, service exports to these three states should soon reach $12 billion annually. Thus, the combined value of goods and services sold to California, Oregon and Washington amounts to almost $26 billion, equal to 55 per cent of B.C.’s total goods and services exports to the United States.
An updated and more complete look at the direction of provincial exports and the role of the three coastal states in B.C.’s global trade underscores the significance of the “Cascadia” region in shaping the province’s economy. When services are counted, this dynamic U.S. region purchases an eye-popping 30 to 33 per cent of B.C.’s international exports. And these are not stagnant markets; all three states have diverse, growing economies. This means there is scope to further deepen B.C.’s already substantial commercial ties with our West Coast neighbours.
Jock Finlayson is the Business Council of British Columbia’s senior adviser; Ken Peacock is the council’s senior vice-president and chief economist.
Chipmakers Are Flashing More Warnings on the Global Economy – BNN Bloomberg
(Bloomberg) — Mounting concern over semiconductor demand is sending shudders through North Asia’s high-tech exporters, which historically serve as a bellwether for the international economy.
South Korean behemoths Samsung Electronics Co. and SK Hynix Inc. have signaled plans to dial back investment outlays, while across the East China Sea, the world’s biggest contract chipmaker Taiwan Semiconductor Manufacturing Co. indicated a similar expectation.
Fading tech demand highlights a darkening picture as Russia’s war on Ukraine and rising interest rates damp activity. The following charts look at the chip industry and its implications for the world economy.
In recent weeks, major chip manufacturers Micron Technology Inc. Nvidia Corp., Intel Corp. and Advanced Micro Devices Inc. have warned of weaker export orders.
Gartner Inc. predicts an abrupt end to one of the industry’s biggest boom cycles. The research firm slashed its outlook for revenue growth to just 7.4% in 2022, down from 14% seen three months earlier. Gartner then sees it falling 2.5% in 2023.
Memory chips are among the most vulnerable segments in the $500 billion semiconductor market to global economic performance, and Samsung and SK Hyinx’ sales of dynamic random access memory, or DRAM, a chip that holds bits of data, are central to Korean trade.
Next year, demand for DRAM is likely to rise 8.3%, the weakest bit growth on record, says tech researcher TrendForce Corp., which sees supply climbing 14.1%. Bit growth refers to the amount of memory produced and serves as a key barometer for global market demand.
South Korea’s exports are bolstered when demand outpaces supply in bit growth. But with supply likely to expand at almost twice the pace of demand next year, exports may be headed for a major downturn.
Signs are rising that trade is already starting to deteriorate. Korea’s technology exports slipped in July for the first time in more than two years, with memory chips leading the falls. Semiconductor inventories piled up in June at the fastest pace in more than six years.
Among potential victims will be Samsung, the world’s biggest memory-chip producer and a linchpin of Korea’s trade-reliant economy.
Samsung recorded rapid sales growth when demand was strong relative to supply. As the chip outlook turns gloomy, shares of Samsung have been declining this year, with occasional rebounds on better-than-expected profits.
Samsung and SK Hynix control roughly two thirds of the global memory market, meaning they have the power to narrow the gap between supply and demand.
Memory is loosely tied to other types of semiconductors, built by firms such as TSMC that produces chips in iPhones, and Nvidia, whose graphics cards are used in everything from games to crypto mining and artificial intelligence.
The Philadelphia Semiconductor Index, which includes these firms, has ebbed and flowed together with memory demand in recent years.
Korean exports have long correlated with global trade, meaning their decline will add to signs of trouble for a world economy facing headwinds from geopolitical risks to higher borrowing costs.
Micron Technology, the world’s third-largest memory maker, last week issued a warning about deteriorating demand, triggering a selloff in global chip stocks.
Korea’s stock market has been among leading indicators of the country’s trade performance, with investors dumping shares well before exports slump.
“The trend is important for Asia as its economic cycle is very dependent on tech exports,” said Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA. “Fewer new orders and the large inventory pile-up mean Asia’s tech sector will see a long destocking cycle and a shrinking profit margin.”
The International Monetary Fund last month downgraded its global growth forecast and said 2023 may be tougher than this year.
Deutsche Bank AG sees a U.S. recession starting in mid-2023 and Wells Fargo & Co. expects one in early 2023. A Bloomberg Economics model sees a 100% probability of a US recession within the next 24 months.
©2022 Bloomberg L.P.
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