UK markets brace for prolonged political uncertainty

British markets braced for more political uncertainty on Wednesday, with investors keen to see if the new finance minister loosens the purse strings and wondering whether Prime Minister Boris Johnson will survive an exodus of support.

The pound dropped to more than two-year lows against the dollar but British stocks climbed.

Some analysts attributed the gains to hopes for more public spending, but the rise in share prices was in line with gains across broader markets and followed big falls on Tuesday, when Johnson's grip on power was rocked by Rishi Sunak quitting as finance minister and Sajid Javid resigning as health secretary.

Several others have left their junior ministerial or envoy roles. 

Analysts said markets would struggle until they had a better understanding of the priorities of Nadhim Zahawi, the new finance minister, and whether Johnson could weather the storm. 

UK stocks, which fell heavily on Tuesday along with a wider market selloff, rose on Wednesday. Britain's FTSE 100 was up 1.60% while the more domestically focused FTSE 250 rose 1.24%, broadly in line with euro zone shares.

The pound slipped to $1.1877 , its lowest level since March 2020. Against a broadly weaker euro the pound was up 0.3% to 85.635 pence .

"For now, financial market reaction has been limited, with markets focused on international developments, including the prospect of recessions in key international economies, tightening global financial conditions and looming energy shortages," said David Page, head of macro research at AXA Investment Managers.

"However, the longer UK political uncertainty persists, the more we would expect it to be apparent in UK financial markets."

Broader economic developments, including concerns about the fallout from a new surge in natural gas prices, had hit UK stocks and sterling hard on Tuesday and continued to overshadow the political drama unfolding in Westminster.

"Financial markets will evaluate developments here in terms of their impact on economic policy. Expectations are that the new chancellor will lean towards more fiscal generosity than his predecessor has been recently," said Paul O'Connor, head of UK-based Multi Asset Team at Janus Henderson.

But O'Connor said the new finance minister faced huge challenges, including collapsing consumer confidence, decades-high inflation and a slowing economy.

"The new chancellor is not going to be in a position to substantially alter the course of the UK economy," he added.

MORE VOLATILITY
While Johnson's new team could unveil populist spending measures in the short term to shore up his support, his premiership remains in doubt after the slew of resignations from ministers saying he was not fit to govern.

Johnson defied growing calls to step down, saying he would "keep going" when questioned by a lawmaker from his own party whether there were any circumstances under which he should resign. 

Investors expect little respite in the near term for sterling. Implied volatility on the British pound hit a two-week high as traders expect a rocky road for the currency.

The BoE's trade-weighted sterling index , which measures the pound against a basket of currencies, fell on Monday to its lowest since January last year.

Bookmakers have ramped up bets of Johnson's departure before the end of the year to as much as 85% on Wednesday from 50% on Tuesday, according to RBC Capital Markets.

"We see two key factors driving the markets' indifference to political risk in the UK. Firstly, markets have now all but written off Johnson as PM going forward," said Stuart Cole at RBC, citing the bookmakers' data.

"Secondly, there is no clear frontrunner to replace Johnson, so it is hard to take a view on what his departure would mean for policy."