An election at last

Prime Minister Sunak has ended months of speculation by calling an election on the 4 July. This
was very much a case of when rather than if – an election had to be called by January under
Parliamentary rules, with an autumn election widely expected, as this would give the Chancellor another opportunity to appease voters with tax cuts.

What explains the earlier timing? The economy is expected to improve this year, and inflation is likely to continue to fall in the coming months, which could make the case for delay. However, Conservative popularity in the polls remains on a downward trajectory, and market expectations of rate cuts have fallen significantly since the start of the year.

While turnout is expected to be low, summer elections tend to attract more voters than winter elections.

For some time, polls have suggested that Labour are likely to win a significant majority. This would give
Labour a reasonable degree of freedom to pursue policy reforms. A narrower majority for Labour could
make Keir Starmer more reliant on the left wing of the party, which could mean a greater chance of
redistributive policies.

While Labour are expected to win a landslide majority, elections can be unpredictable, and they would need to win a significant number of seats, after major losses in 2019. A hung parliament would require support from the Lib Dems or SNP, andwould reduce the policy room available.

While we do not yet have manifestos for either party, Labour has made clear its policy plans, which focuses on three areas.

Strengthening business confidence in the UK is a priority, committing to Bank of England independence, strengthening the Office of Budget Responsibilities mandate, capping the corporation tax rate at 25%, and quickly publishing a ‘roadmap’ for business tax.

Private investment is also key, through planning reforms to boost housebuilding, a more interventionist industrial strategy and government investment to ‘crowd in’ private sector contributions.

Labour-market reform is also in focus, seeking to increase employee participation, increase workers' rights to holiday and sick pay, as well as reversing the current government’s union law changes.

In aggregate, such policies could modestly raise the potential growth rate of the UK economy and indeed the pace of GDP growth, but many of these reforms will take time to implement.

In reality, the economic implications of the elections are likely to be relatively modest. Firstly, unlike the last election, there is relatively little room between the policy stance of Labour and the Conservatives.

Secondly, the UK faces a more constrained fiscal backdrop, which leaves limited room for changes to fiscal policy. This reflects the higher interest burden faced by the Treasury, the impact of unfavourable demographics on the public purse, as well as greater caution at the Exchequer after the Truss mini-budget bond rout.

Given how consistent polls have been, markets are pricing in the likelihood of a Labour majority. This is
likely modestly positive for GDP growth, and slightly negative for the outlook for public borrowing, insofar
as public borrowing is likely to be somewhat higher under a Labour government. Overall, this may see
the UK’s credit outlook downgraded modestly, and it could be negative for gilts.

On the monetary policy side, there is likely to be relatively little impact. We have one Bank of England
meeting ahead of the election, at which rates are unlikely to be changed because of economic
fundamentals. Further out, the impact is likely to be small. However, if the Bank is able to cut rates ahead
of the Fed, as we expect, this could see sterling weakening relative to the dollar.

On the equity side, UK stocks have enjoyed greater support lately. Given that a Labour majority is likely
priced in, there may not be a great deal of further upside on such an announcement. However, UK
equities remain under-owned globally and a shift in sentiment could support significant flows back to the
UK. This can be difficult to predict but would likely require a significantly brighter outlook for the UK’s
growth potential.

There are some areas of the market that we expect to be more sensitive in coming months. The
alternatives space is likely to be impacted to a greater degree by changes in policy and fiscal and
monetary decisions. Certain equity sectors could also be more sensitive, for example energy. Labour has
pledged to renew efforts for the energy transition, after the Conservatives watered down green pledges.
This could incentivise investment in the necessary infrastructure – as an example, National Grid has today announced an accelerated capex plan over the next five years. It could also have an impact in
taxation for companies involved in fossil fuels, and raises questions of how to fund the transition.

With more than a month to go before the election takes place, there is much yet to be revealed in terms
of detailed policy announcements. Moreover, UK elections can be tricky to predict. However, the
political space between Labour and the Conservatives has narrowed significantly since the 2019 election, reducing the variance of possible outcomes. Whilst we remain alert to the unexpected, a shift in the policy agenda, or a low probability election result such as a hung parliament, we expect the impact of the election on asset markets to be moderate. Moreover, as multi asset investors, our exposure to the UK is limited, and balanced with investments in other regions. As ever, we will continue to pay close attention to global economic conditions, especially in the US and China.

 

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The information contained in this document is believed to be correct but cannot be guaranteed. Past performance is not a reliable indicator of future results. The value of investments and the income from them may fall as well as rise and is not guaranteed. An investor may not get back the original amount invested. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Where links to third party websites are provided, Close Brothers Asset Management accepts no responsibility for the content of such websites nor the services, products or items offered through such websites.