LONDON — As Rishi Sunak becomes the U.K.'s third prime minister in as many months, some analysts are re-assessing their outlook for British stocks, but most remain cautious in the face of a wall of economic headwinds.
The realization that Sunak would succeed Liz Truss — following the withdrawal of controversial former leader Boris Johnson and Penny Mordaunt from a prospective leadership contest — gave markets an initial boost on Monday.
The former finance minister was seen as a stabilizing force after the economic chaos unleashed by Truss's 44-day tenure, but the initial relief rally proved fragile and Britain's FTSE 100 was down 0.7% by afternoon deals on Tuesday.
Despite the converging macroeconomic, political and market crises waiting in Sunak's inbox on his arrival in 10 Downing Street, however, some analysts are already unwinding their gloomy prognosis for U.K. stocks.
"The fact that we have Rishi Sunak as prime minister is definitely calming on markets. We saw that yesterday with a 37-basis point decline in the 2-year gilts. We see this as good news – the fact that there is some stability on that side," Charles-Henry Monchau, chief investment officer at Bank Syz, told CNBC on Tuesday.
"We also believe that he might be able to bring this fiscal stability which is very needed in the U.K., and it might surprise you that we recently upgraded U.K. equities to neutral because we were negative on this market before. We believe that it is under owned, it's unloved, undervalued, and there is some upside from here."
Although the broad sigh of market relief was acknowledged by many market participants, others were slightly more hesitant over the medium term given the country's plethora of challenges.
"The lack of need to roll the dice with Tory party members again and the speed with which the new PM can now enter number 10 make this outcome the most market friendly one that was possible in the short term. That's probably in the price now," said James Athey, investment director at Abrdn.
"The economic future however remains fraught; inflation remains far too high and the Bank of England hasn't yet really grasped the nettle. As such, the future is far from ideal for UK investors."
Return to fiscal normalcy?
Sunak in his inaugural speech outside Downing Street on Tuesday stressed the importance of "economic stability and confidence" while warning of "difficult decisions to come."
He is expected to back current Finance Minister Jeremy Hunt's planned return to tightening the fiscal belt, in contrast to the controversial tax-cutting plans laid out in Truss' "mini-budget" against a backdrop of double-digit inflation.
Subsequent moves in long-dated U.K. government bonds — known as gilts — forced the Bank of England to launch a two-week emergency bond buying program in order to prevent pension funds from imminent collapse.
Bank officials also noted a need for more "significant" rises to interest rates to counter the inflationary impact of Truss' fiscal spending.
The Bank has now ended the purchase program and confirmed plans to begin its delayed gilt sales at the end of the month. Central to the potential stability narrative, as far as U.K. markets are concerned, is the assumption that the central bank will now be less aggressive in raising interest rates.
"I do think with the new prime minister coming on, with the new chancellor coming on as well, that the markets see there is going to be more predictability and more consistency between fiscal policy and central bank policy, and with that also more consistency, and I think the market is always looking for consistency there," UBS CEO Ralph Hamers told CNBC on Tuesday.
Paul Hollingsworth, chief European economist at BNP Paribas, said the change of direction to a more traditional fiscal stance was "good news overall" in that the "uncertainty risk premium had been an additional headwind to the outlook."
"It also likely goes some way in restoring the credibility of U.K. institutions. Monetary and fiscal policy will no longer be working at cross-currents with each other," Hollingsworth said.
"Sunak was a very vocal opponent during the summer leadership campaign of the suggestion of revisiting the BoE's independence. And Sunak will likely embrace the role of the OBR [Office for Budget Responsibility] when it comes to the transparency of fiscal decisions."
Yet against a bleak fiscal picture, the "difficult decisions" to which Sunak alluded will make it hard to claw back the electoral damage inflicted by Truss and Johnson's prior premierships, with the Conservative Party polling at historic lows and a general election slated for 2024.
"Admittedly, in the short term, it likely means the BoE will deliver less policy tightening (we expect 75bp next week rather than our expectation of 100bp immediately after the mini-Budget)," Hollingsworth said.
"That may help Sunak present the view that he has prevented a steeper rise in mortgage rates. In the medium-term, however, spending cuts against a backdrop of already-squeezed public services will be challenging electorally."