The unexpected change in chancellor is likely to open the UK’s fiscal floodgates, according to economists, supporting an outperforming UK stock market, stronger pound and higher gilt yields. 
During a reshuffle of prime minister Boris Johnson’s cabinet yesterday, Sajid Javid (pictured) surprised by resigning as chancellor – eight months into the job and just four weeks ahead of what would have been his first Budget.
The resignation came after Johnson offered to reappoint Javid, but only if he fired his team of aides. Javid later said this condition left him “no option” but to resign, as “no self-respecting minister would accept” it.
Rishi Sunak has been appointed as chancellor. Sunak, a former hedge fund manager and investment banker, had been chief secretary to the Treasury since July 2019; his only ministerial appointment prior to this was being made a junior minister at the Ministry for Housing, Communities and Local Government in January 2018.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, described Johnson’s demand that the chancellor sack all of his advisers was “a naked power grab”, adding that “the changing of the guard at Number 11 signals that fiscal profligates are in charge of the government”.
Last year, Javid committed to targeting a balanced current budget over a rolling three-year time frame and to limit borrowing for investment to 3 per cent of GDP, which at the time gave him a decent amount of fiscal firepower.
However, it now appears that Javid would have had to announce fresh spending cuts or tax increases if he were to adhere to his rules. The prime minister, on the other hand, is a fan of loosening the purse strings for big infrastructure projects, while cutting taxes.
Fresh tax rises or spending cuts needed to meet Javid’s rule
Source: Pantheon Macroeconomics
“We doubt Javid, or the prime minister, thought their hands would be tied so quickly after announcing their new, looser fiscal rules. Initial Budget-related discussions between Number 10 and 11 over recent weeks likely highlighted this issue, with Javid sticking by his rules and Johnson wanting to abandon them,” Tombs said.
“Javid’s resignation, only eight months after assuming the role, is the clearest sign yet that the Johnson-led government wants fiscal policy to play a bigger part in stimulating the economy over the next couple of years.
“In the fresh-faced Sunak – who has been an MP only since 2015 and consistently loyal to Johnson – the prime minister has a ‘yes man’ in position at the Treasury, who won’t resist pressure to spend more, if the economy starts to buckle under the strain of Brexit.”
The economist added that it is unclear whether Sunak will drop Javid’s rule ahead of the Budget or wait longer to do this. He still has a strong incentive to run a balanced current budget so that he can preserve fiscal firepower for 2021, when the effects of Brexit will start to be seen in the economy, or to be able to boost the economy ahead of the next general election.
“Nonetheless, we think investors have correctly interpreted the change at Number 11 as a signal that fiscal policy will be looser than it otherwise would have been, and monetary policy will be slightly tighter,” Tombs said. “Investors now see a 35 per cent chance that the Monetary Policy Committee will cut rates by June, down from 42 per cent before Javid’s resignation.”
Capital Economics said the change of chancellor supports its view that the sterling will continue to strengthen, the UK stock market will outperform its international peers and gilt yields will rise, on the back of a stronger economy.
Changes in MSCI local-currency equity indices from current levels to Capital Economics’ end-2021 forecasts (%)
Source: Bloomberg, Capital Economics
The macroeconomic forecasting house already thought that the Budget on 11 March would see an extra loosening in fiscal policy worth 0.5 per cent of GDP, which when combined with extra government spending announced in September 2019 would mean a fiscal boost of around 1 per cent. But with Sunak in place, the Budget could now provide “a bigger bang” through more increases in public investment and further tax cuts.
Paul Dales, chief UK economist at Capital Economics, said: “Sunak’s previous votes in Parliament suggest his views are perhaps more aligned with those of the prime minister and his chief special adviser Dominic Cummings than Javid’s.
“His voting history shows he’s an ardent Brexiteer, supports reductions in corporation tax, cuts to capital gains tax and he’s gone on the record as favouring infrastructure investment. So this is either going to be a meeting of minds or Sunak will be the prime minister’s ‘yes man’ living in Number 11.”
Capital Economics expects sterling to climb to $1.35 by the end of 2020 and to end 2012 at $1.40, while it sees the 10-year gilt yield will continue to reach 1 per cent this year and 1.25 per cent by the end of next.
Meanwhile, it forecasts that stronger economic growth, reduced Brexit uncertainty, and the possibility of corporate tax cuts means the MSCI UK index will be the best performer among similar indices for the 10 largest developed economies’ stock markets.