Keir Starmer, the Labour leader, will today become Prime Minister of the UK with a majority of close to 170 MPs. Labour gained over 200 seats while Conservatives lost close to 250 in their worst ever election result. Other notable changes in the House of Commons include impressive gains for the Liberal Democrats to over 70 MPs, making them the third largest party in Parliament in their best ever result. The Scottish National Party saw substantial losses, and a handful of independents were elected. The Reform party achieved a strong vote share but only four MPs, with their leader, Nigel Farage, becoming an MP on his eighth attempt. The vote share looks quite different to the seat outcome as a result of our ‘first past the post’ electoral system, but nevertheless this is an historic swing away from a ruling party.
So what does this radical political result mean for the UK economy and financial markets?
Not much, at least in the short term! This election result is largely as forecast, with little in the way of material policy change expected. What it does provide markets is more certainty about future policy stability, allowing opportunity for greater business investment into the UK that has been seriously lacking over the last decade. That should help UK economic growth somewhat, but won’t cover up that fact that the country still faces a huge public debt burden and an ageing population, which means some tough choices ahead and headwinds to long term UK asset outperformance.
Labour was at great pains during the campaign to stress that they would not make unfunded spending decisions or raise most of the major taxes substantially. The state of the UK’s finances remains precarious, with large public debt and high taxes already in place at a time when many people are also unhappy with the quality of public services. The impact of Liz Truss’ disastrous budget in 2022, where proposed large unfunded tax cuts caused a spike in interest rates and a collapse in sterling, loomed large over much of the debate and encouraged caution on both sides. Rachel Reeves, the new Chancellor of the Exchequer, has said that there will not be a Budget before the autumn, and that she will work closely with the Office of Budget Responsibility to ensure all spending plans are funded.
Labour explicitly committed not to increase the rates of income tax, national insurance and VAT in the life of this parliament, although thresholds will remain frozen until at least 2027. Therefore, Labour’s fiscal plans are not expected to hugely change the economy’s forecast trajectory. Perhaps the policy areas of most interest to UK equity investors are Labour’s promise to reform the planning system and increase build rates, given the significant number of housebuilders and building materials firms listed on the FTSE All Share. In addition, the government may seek to bring certain infrastructure assets back into public ownership, such as areas of transportation and utilities.
Given the scale of the victory Labour does not need to compromise with other parties, and so are likely to be bound by their manifesto promises. It feels likely, however, that there will be pressure from within the party to find more money for key areas like the NHS and social care, particularly if the economy remains slow. The UK has record levels of long term sickness in the working age population, a less talked about hangover from the pandemic. If the government can find ways of providing the treatment needed and getting people back to work, that may help the longer term economic picture.
This may lead to pressure to either borrow or tax more. Given the explicit commitments given throughout the election, and the cautionary tale of Liz Truss still fresh in voters’ minds, it seems unlikely they will do anything that they perceive will be disruptive to markets. If their commitment to growth pays off that will ease economic conditions; if not there will be some difficult decisions to make in the future.
In summary, whilst sterling might see a small relief bounce now that the election result is confirmed, we don’t expect it to outperform the US dollar for an extended period, so believe it is important to retain healthy international diversification. The UK stock market may also see a short-term rally from this greater political certainty, but many of the challenges it faces competing with global markets, such as its lack of exposure to modern technology, do not change with a new government. We expect UK stocks to remain cheaper than international peers, in aggregate, and are assessing infrastructure exposures where there may be risk of nationalisation.
However, we retain the significant exposure to UK government debt that we have added for clients over the last 18 months, which we think offers reasonably attractive risk adjusted yields in anticipation of lower inflation in the near future. The new government’s fiscal caution may weigh on growth potential, but it should ensure financial stability and allow the Bank of England a clear path to ease interest rate pressures in the economy.
The opinions expressed in this note are not intended as investment advice and are based upon Epworth’s views and projections at the time of writing. They may change at any time. If you are considering investing in any market, please consult an independent financial adviser or other professional adviser before making an investment decision. The value of investments and the income generated by them can fall at any time. The investment services and products offered by Epworth Investment Management Limited are not suitable for an investor if the possibility of capital losses or reduced income cannot be accepted.”
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