May resignation raises UK recession risk

10 Downing Street

Prime Minister Theresa May has now announced her resignation, stepping down on 7 June. This will trigger a Conservative Party leadership contest, the winner of which would also become prime minister.

May’s resignation follows the end of Brexit talks with the opposition Labour Party, which officially concluded without agreement.

At this stage, bookmakers have the former foreign secretary and mayor of London Boris Johnson as favourite. The hard-line Brexiteer could easily take the UK out of the EU without a deal, despite parliament voting in favour of essentially removing the option. He could do this by simply failing to comply with the EU’s demands that the UK should continue to follow the rules. This presumably would lead to the EU agreeing to terminate the relationship in October.

If this were to happen, we would anticipate the economy to slow and fall into recession around the turn of the year. While the Bank of England would probably cut interest rates eventually, the expected depreciation in the pound would cause inflation to spike. The household sector has already run down its safety buffer in the form of its savings rate, therefore a contraction in demand is very likely.

It is hard to see how a compromise across various stakeholders can be resolved before 31 October

The mixture of the unwillingness of the EU to re-negotiate, the lack of appetite for hard-Brexit at the parliament and potentially toughened stance on Brexit by a new prime minister points towards further political turmoil. It is hard to see how a compromise across various stakeholders can be resolved before 31 October. Ultimately, a political process such as snap election or a second referendum may need to take place to find a way forward.

As a result of the additional Brexit uncertainty, we expect UK economic activity to face further headwinds. The recent intensification of political turmoil has caused a sell-off in sterling to a 4-month low versus the dollar.

At the time of writing, sterling has not reacted meaningfully after Theresa May’s resignation, hence it is a reflection that the news has been priced in. Going forward, sterling is likely to remain volatile and subject to downside risks in reaction to Brexit headlines.


The above article was previously published by Schroders on 24th May 2019