The best that new chancellor Nadhim Zahawi can hope for is to "help steady the ship until the global economic storm has passed", as the industry responds to the recent spate of resignations threatening Boris Johnson's premiership.

The quote comes from head of multi-asset at Janus Henderson Investors Paul O'Connor, who joins analysts reacting to the shock resignation of Rishi Sunak last night (5 July) in warning that Zahawi is unlikely to be able to tackle the sharp economic slowdown and continually high inflation that the UK is experiencing.

Richard Carter, head of fixed interest research at Quilter Cheviot, said: "Markets are playing close attention to the unfolding drama in British politics although arguably have bigger things on their mind with rising interest rates and the impending threat of recession.

"Given the rapidly changing events, it is unlikely that the new chancellor Nadhim Zahawi will have long to put his stamp on economic policy before a leadership election is triggered."

Carter concluded that to tackle the serious economic problems facing the UK, "an end to the Tory infighting is probably necessary first."

Nadhim Zahawi appointed chancellor following Sunak resignation

O'Connor agreed that Johnson was unlikely to remain in office long, arguing that "his political power is fading" as "he has lost the support of the electorate and his popularity among his own party is rapidly declining".

He added: "Financial markets will evaluate developments here in terms of their impact on economic policy. The outgoing chancellor has highlighted differences in opinion on fiscal policy as being a key reason behind his resignation."

Nevertheless, O'Connor warned that the new chancellor "faces formidable challenges".

"He inherits an economy in the grip of a cost-of-living crisis, with consumer confidence at the lowest level on record, below those seen during all the recessions since 1980.

"With inflation at a 40-year high and looking set to hit double digits soon, the Bank of England is likely to be metronomically raising interest rates at all its remaining MPC meetings this year. The new chancellor is not going to be in a position to substantially alter the course of the UK economy."

Taxation

Julia Rosenbloom, tax partner at Evelyn Partners, noted that Zahawi had already stated that "nothing is off the table" around the tax regime. She said that "to help him stamp his mark as chancellor, it is quite possible that Zahawi may want to hold an emergency or early Budget where a different direction in tax policy could be announced".

Carter noted that Zahawi "will almost certainly come under pressure from Johnson to cut taxes in an attempt to try and boost economic growth (as well as please voters) even if that puts further strain on the public finances".

O'Connor explained that the expectations of the new chancellor leant towards "more fiscal generosity than his predecessor has been recently".

However, he concluded that due to the poor economic condition of the UK, "some targeted fiscal measures seem more likely than an attempt at introducing a transformative new policy regime".

Sterling

Gabriele Foà, co-portfolio manager at Algebris Investments, said that the short term effects of Sunak's resignation, along with health secretary Sajid Javid, will lead to more sterling volatility.

"After last month's confidence vote, Johnson's position is clearly more unstable and increased uncertainty around the next government will weigh on the currency."

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Nigel Green, CEO of deVere, agreed, arguing that while slowing growth has likely had a greater impact on the pound, "there is no getting away from the fact, this all creates more much more uncertainty for sterling".

"The issues laid bare by Johnson's possible successors that will impact the pound would include the UK's relationship with the EU and single market access, fiscal stimulus and the Northern Ireland protocol, amongst others."

He concluded: "Sterling is falling out of favour currently for myriad reasons, including politics."

The pound dropped to its lowest level since March 2020 last night, before recovering somewhat this morning.

However, Foà argued that beyond the immediate short term drop, "markets may see a change in government as a positive catalyst for GBP".

"Brexit uncertainty, oscillating economic policies and more politicised Bank of England communication have been important factors behind Sterling's weakness over the last 12 months. Improvement in any of these areas could provide relief for the currency and UK assets in general."