Receding risks of summer political turmoil could partially restore the supremacy of economic fundaments as the main driver of the outlook. But businesses should be cautious – and prepare for turbulence ahead. The medium-term outlook (the next year or two) remains challenged for the UK, economically and politically. The way in which any future leader responds to the cost-of-living crisis remains uncertain. Uniting the Tory party around any one leader could prove difficult.

All of this has important implications for the direction of UK policy and the outlook for the economy. Here’s our quick take.

We believe an early election – perhaps autumn, or even the spring of 2023 – is likelier than not, and that would be negative for the pound. Not just because it raises the risk of a less market-friendly contender to gain traction; it also puts political risk back in the driving seat, where issues like another Scottish Independence referendum or a change in tack on Brexit come into play.

Early elections also raise the risk of higher (politically influenced) public spending in the near term to tackle the cost-of-living crisis and “level up” the economy. But this in turn could mean that inflation pressures shift even higher, alongside higher government borrowing to finance additional expenditure.

If inflation does accelerate, we could see the Bank of England (BoE) spring into action sooner than expected. Our most recent forecast called for one 25 basis point (bp) interest rate hike in August this year, and two 25bp hikes in February and May next year. But we now think there’s more pressure to bring some of next year’s hikes forward, with one 25bp in August 2022, another in November 2022, and another in February 2023. At the same time, additional public spending raises the risk that the BoE delays or downsizes its quantitative tightening programme.

Higher interest rates sooner than later may translate into higher borrowing costs for businesses. A softer economy due to lower consumer confidence and spending might, however, act as a cap on how quickly interest rates can rise.

The pound is sensitive to anything that affects the growth outlook, so the prospect of more accommodative fiscal policy could help support the currency near term. So too is the prospect of tighter monetary policy sooner. But a drawn-out leadership contest means that currency strength could fade into higher volatility. An early general election would also increase the risk of another Scottish Independence referendum, which would likely add to FX market jitters.

To learn more about how shifts in the UK political landscape could affect you, get in touch with your Lombard representative or contact us here.