UK elections: what are the consequences for the economy and markets?

Another hot event of the year are, without a doubt, the UK elections which will be held on 4th July, as announced by Prime Minister Rishi Sunak who officially kicked off the race for the formation of the next government. If the polls are correct, they will lead to a difficult result for the current government. What is the situation with the UK economy and markets ahead of the election?

United Kingdom, to vote on July 4th

He answers this question Azad Zangana, Senior European Economist and Strategist, Schroders explaining that there are, in particular, “three main questions being asked about the upcoming elections in the United Kingdom. The first concerns timing. At first glance it seems strange, but perhaps not so much when you consider a likely slowdown in growth, after a surprisingly strong first quarter, combined with stiffer-than-expected inflation. Higher inflation would appear to be able to ward off interest rate cuts and with them the prospect of a reduction in mortgage costs in the immediate future”

The decision to hold elections in the summer “is a bit surprising, given that many expected elections in the fall. Elections close to the holidays risk registering low voter turnout. This timing also does not fit with the Conservatives' message that the economy is strengthening and inflation is “back to normal.” The latter data implies that interest rate cuts will follow shortly, which should certainly strengthen support for the incumbent party.

What consequences for the economy and markets?

Sunak said “the economy is growing faster than anyone predicted,” referring to surprisingly strong first-quarter GDP growth estimates that signaled the end of the UK recession. While the decline in inflation was substantial, it was primarily due to a reduction in household energy bills and base effects. April's CPI inflation was indeed disappointing, as consensus estimates predicted a decline to 2.1%. As a result, expectations for the Bank of England's (BoE) first interest rate cut have shifted from June to September, resulting in higher mortgage costs for those refinancing in the near future. Furthermore, our model suggests that inflation is expected to rise from July, moving away from the BoE's target of 2%. This could call into question government claims that inflation has returned to normal.

Who will win the elections?

The second question is: chWill he win this election? The polls should be taken with a grain of salt but, with the election campaign just starting, the opposition Labor Party has a huge, apparently unassailable lead of 21 percentage points over the Conservatives, which has remained fairly constant.

This – continues the expert – “naturally leads to third question: What could a Labor government mean for the UK? There isn't much concrete information to work with at the moment. In light of this lead in the polls, the Labor Party felt no pressure to announce its programme. Shadow Chancellor Rachel Reeves' speech for the Mais Lecture on 19 March offered some insights. The message of: “building growth on strong and secure foundations, with an active government guided by three imperatives. First, ensure stability; secondly, stimulate investment through partnership with businesses; third, reform to unlock workers' contributions and untapped potential across our economy.”

The possible scenarios

The first “imperative” is a clear dig at the political instability of the last government, in particular of the L eraiz Truss. The second imperative appears to be an olive branch to businesses, which have had good reason to fear the Labor Party's past leadership. Demonstrating that a Labor government can work successfully with business is important not only for attracting foreign direct investment, but also for cementing its reputation in the eyes of financial markets. Finally, focusing on reforms to increase productivity and prosperity is an obvious action, even if there is very little policy initiative at this stage. There was also a significant section on what Reeves calls “securonomics,” which seems to signal a more thoughtful approach to international trade and globalization, which could ultimately mean protectionist policies against China. In terms of fiscal policy, there is a clear desire to improve public services, which will undoubtedly lead to an increase in public investment. The new fiscal rules are likely to exclude public investment and focus only on day-to-day spending, known as the “current budget.”

The target “it will probably be to balance the budget current using tax revenues, but to allow borrowing to pay for major public investments. This is in order to reduce overall debt in the medium term. While Labor avoids talk of tax rises, the election campaign will inevitably force the party to offer more detail. Some tax increases are likely to be needed, which is difficult given the “fiscal drag” which is occurring as a result of the freezing of income tax thresholds over the past seven years.

Finding solutions to the long-term structural challenges of the UK economy “will be key to raising growth and living standards. These challenges include an aging population, adaptation to climate change, a more hostile external business environment and poor productivity growth. Hopefully this will also mean improved returns for investors, who have long largely avoided the UK public markets,” concludes the expert.

UK stocks

As for stock investment – ​​he explains Graham Ashby, Fund Manager, UK All Cap, Schroders – “always involves risk and trying to predict changes in markets is far from an exact science, just like politics. That said, sentiment towards UK shares is very low and we wonder whether a change of government in the UK could coincide with a turnaround in sentiment.”

With sentiment so low towards UK stocks, contrarian investors “they could support cthat things can only get better. The legendary Warren Buffett once observed that it is wise for investors to “be fearful when others are atI saw and greedy when others are fearful.”

Is it time to be greedy?

“Certainly some contrarian indicators suggest yes. And a new government could improve some conditions for British stocks. Just think of the very low levels of domestic pension fund equity allocations, especially compared to other countries,” explains Ashby, underlining that “no one has a crystal ball as to the exact timing, but it is unlikely that domestic pension funds will be able to further reduce and significantly their exposure to UK equities.”