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United Kingdom Politics August 2022

United Kingdom: UK prepares for a new Prime Minister; extra fiscal support likely

Liz Truss is the favorite to become Prime Minister in September, and promises tax cuts.

The cost-of-living crisis is likely to force the next PM into greater fiscal handouts to vulnerable households.

Relations with the EU will likely stay tense.

What’s happening: The result of the Conservative Party leadership election between former Chancellor Rishi Sunak and Foreign Secretary Liz Truss will be announced on 5 September. The winner will become Prime Minister, as Boris Johnson announced in July that he would step down following the outcome of the vote. The latest polls suggest that Truss has a commanding lead.

What the candidates are promising: Liz Truss has campaigned to cut taxes immediately if elected, by reversing the recent National Insurance increase, suspending the green levy component of energy bills and cancelling next year’s planned hike in corporation tax. These measures would have a cost of slightly over GBP 38 billion. Truss has also proposed boosting defense spending to 2.5% of GDP by 2026 (from its current level of around 2%). With no corresponding commitment to cut other areas of spending, the upshot would likely be a larger fiscal deficit, and higher inflation and public debt compared with current policies.

In comparison, Rishi Sunak has emphasized fiscal restraint and containing inflation. While in recent weeks he has launched his own tax cut proposals in a bid to garner more support—pledging to trim income tax in 2024 and to cut VAT on energy bills—the measures are less fiscally expansive than Truss’.

What comes next: Whoever wins the leadership election will take over a flagging economy, as interest rates rise and energy bills surge. Faced with political pressure to address the cost-of-living crisis, the new prime minister is likely to announce extra financial support to vulnerable households in the near term, independently of both candidates’ current spending pledges. Moreover, not all of the campaign policies are likely to become reality—particularly Truss’ large tax cuts—given the need to appeal to the broader electorate ahead of the 2024 general elections rather than just to Conservative Party members.

Regarding foreign policy, while relations with the EU could become superficially more cordial under a new Prime Minister, underlying tensions are set to persist. Liz Truss would likely adopt a combative approach to dealing with the bloc: She introduced the bill to modify the Northern Ireland Protocol, for instance, which the EU judges to be illegal. Moreover, in her role as foreign secretary, in August Liz Truss activated formal dispute proceedings regarding the UK’s access to the EU’s science programs. Rishi Sunak has also suggested he supports the Protocol bill, but could offer a more conciliatory approach towards EU negotiations.

On fiscal policy, Berenberg’s Kallum Pickering said:

“Both candidates have promised a lot on the campaign trail in terms of economic policy. However, […] it is far too early for investors to start to place bets on what policies the UK will follow. The profane constraints of office often dramatically curtail the lofty economic ambitions of would-be PMs. When vague (and often expensive) promises meet the fiscally-hawkish Treasury’s budget accounting and the day-to-day need to keep the public sector and all its commitments properly financed, policies are often dramatically downsized.”

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