In Ernest Hemingway’s The Sun Also Rises, a character, when asked how he went bankrupt, replies, “Two ways. Gradually, then suddenly.” Much the same can be said to describe how Boris Johnson’s position as UK Prime Minister ended. After what can be politely described as two days of utter domestic political chaos, PM Boris Johnson signalled his intention to resign earlier this morning. He intends to remain in situ at 10 Downing Street as caretaker prime minister until a replacement is chosen.

It is not clear what finally triggered his decision to quit. However, the forces within the Conservative Party were becoming insurmountable. Losing his Health Secretary and Chancellor on Tuesday within minutes of each other was reminiscent of July 2018 when Mr Johnson resigned as Foreign Secretary from Theresa May’s government, less than 24 hours after David Davis departed as Brexit Secretary. And the sheer weight of the number of Cabinet ministers urging him to quit yesterday was a throwback to 1990, in the final days of Margaret Thatcher’s tenure as PM.

The next stage will be for the Conservatives to elect a new leader. The process is that Conservative MPs vying for the leadership need to declare their candidacy. Then all Tory MPs will eliminate the contenders one by one in successive rounds of voting until two remain. After a campaign, there will be a head-to-head vote among grassroots party members to select the leader. The timetable for the rounds of voting among MPs will be announced next week and, depending on the number of candidates, should be completed relatively quickly. However, the membership vote will not likely to be concluded until autumn.

Despite his plans, it may be difficult for Mr Johnson to carry on in the interim, bearing in mind the opposition to his leadership among his MPs. One alternative would be for Deputy PM Dominic Raab to assume the mantle. Indeed Mr Raab ran the country for a short period while Mr Johnson was ill with Covid in 2020. Irrespective of who becomes the temporary leader, the UK will lack firm policy direction until the ‘permanent’ PM is in place. In the context of the cost of living pressures and the war in Ukraine, maintaining a holding pattern risks being particularly problematic. It is helpful that the parliament goes into recess in two weeks’ time until September. Also, the new government will have time to prepare for an autumn Budget. But in the meantime, there will be a vacuum as huge question marks remain over the direction of policy.

"A thick layer of political fog has descended upon the UK.”

Who is likely to replace Boris? For the moment, this remains very unclear. Over the next few days, we will better understand who the candidates are. Over recent days, bookmakers’ odds have varied across a relatively narrow range of candidates, with no clear favourite. At the time of writing, the frontrunner was Defence Secretary Ben Wallace. But Tory leadership races are notorious for the favourite not winning (the recent exception was Boris Johnson in 2019). Even when a new PM is installed, we expect the opposition parties to claim that he or she has a mandate from the Conservative Party but not the nation as a whole. Pressure to hold a General Election would mount.

In the interim period before a new prime minister is installed, the outlook for economic policy naturally looks murky. Until his resignation on Monday, Chancellor Rishi Sunak was expected to give a joint speech on the economy with PM Johnson next week. For a long time, press reports suggested clashes between Sunak’s more fiscally cautious stance and Johnson’s more free-spending attitude. These were confirmed in the Chancellor’s resignation letter. Sunak’s departure paved the way for a more sympathetic attitude to Johnson’s view by the next Chancellor, Nadhim Zahawi, promoted into this role on Tuesday. Indeed, Zahawi indicated in press interviews that the planned hike in the corporation tax rate from 19% to 26% in 2023/24 could potentially be scrapped to maintain global competitiveness. He is said to have been instructed to look into immediately cutting fuel duty and perhaps also the standard rate of VAT as well as income tax rates, along with lifting the tax thresholds with inflation, to help address the rising cost of living. Similarly, he is reported to oppose windfall taxes on oil and gas companies. At the same time, though, he noted the need to be fiscally responsible to rein in high and rising inflation, including by being ‘really careful’ as regards public sector pay.

"The response to any looser fiscal policy by the Bank of England may be to hike rates more aggressively to counter the resulting upward pressure to inflation that this would bring about.”

However, it is doubtful whether this incipient shift towards a looser fiscal policy will be able to continue under a caretaker prime minister. Certainly, it would seem difficult to make such moves ahead of a formal Budget, notwithstanding the pressures to offer further support to households hit the most by the cost of living crisis. However, should the next leader of the Conservative Party agree with this directional shift, the response to any looser fiscal policy by the Bank of England may be to hike rates more aggressively to counter the resulting upward pressure to inflation that this would bring about. Much, however, will depend on the nature of the incoming government. The same can be said for other flagship economic policies with longer-term ramifications, such as ‘levelling up’ and net-zero.

Generally, a state leader resigning and creating new political uncertainty would cause a sharp sell-off in the country's currency. However, sterling has climbed this morning following the announcement of Boris Johnson's resignation, albeit from a low level. Against the USD, sterling now sits at $1.1960, up from below the $1.1900 level yesterday afternoon, and GBP is around 85 pence against the euro, which is a two-week low.

One could argue that Mr Johnson's departure removes, or at least lessens, some of the downside risks facing the pound. In its discussions over the Northern Ireland protocol, Boris Johnson's government has become increasingly hostile towards the EU in recent months, running the risk of increasing trade frictions with the EU. In addition, as public dissatisfaction with the UK government grew, Scottish independence may have seemed more appealing to Scottish voters. The SNP's request for a second referendum has been rejected. Still, Scottish First Minister Nicola Sturgeon has said that the next general election will become a 'de facto' referendum if no second vote is permitted. A change at No. 10 may help to douse Scottish appetite for separatism. But all depends on who becomes PM and the precise makeup of the new Cabinet and for now, a thick layer of political fog has descended upon the UK.