Opposition Labour Party on course to win UK general election

Today is election day in the UK, where, if the opinion polls are to be believed, the UK will see an end to 14-years of Conservative Party rule and a new Labour government - a party that last tasted power in 2010 – take office. Typically elections such as this generate market interest and uncertainty, expressed through increased volatility in the local currency and domestic asset prices. But so far this election has failed to have any material impact on the markets, which have largely shown an indifference to the outcome.

Below we set out some analysis on this, looking at why the Conservative Party decided to call an early election despite trailing in the polls, why the market is showing so much disinterest, what a Labour government might mean for the UK in terms of economic policy, and what the post election economic landscape might look like, including where any potential volatility might be found.

WHY THE EARLY ELECTION CALL?

UK opinion polls have shown the Labour Party to be enjoying more support in the country than the Conservative Party since November 2021, this lead increasing after former prime minister Liz Truss left office in October 2022 to show a sustained lead of around 20% and pointing to a majority in Parliament of around 160 seats. A big question, therefore, is why current Prime Minister, Rishi Sunak, decided to call an election now rather than wait until the last possible moment in January 2025, which would have given him another six months to try and close this gap. Our suggestion is that the early call was predicated on economic factors: firstly, inflation finally falling back to its 2% target; and secondly, on the better run of UK growth figures seen (the economy grew by 0.7% in Q1). Both these things have enabled the Conservative government to claim their economic policies are ‘working’, an argument that would have been difficult to make had an election been delayed, given that inflation is expected to rise again over the Autumn, possibly to as high as 3%, and growth is forecast to slow to a much more tepid pace of 0.2% per quarter over H2. Accordingly, Sunak likely determined the current economic news was as good as it was going to get ahead of next January.

WHY IS THERE SO LITTLE MARKET INTEREST?

Normally, UK general elections are associated with periods of heightened market uncertainty, particularly when there is the possibility of a change in administration and a new direction for economic policy that such a change implies, given the opposing economic and social philosophies the Conservative Party and Labour Party each pursue. So why are we not seeing that volatility this time around?

The first key reason is the opinion polls. Despite the better economic news seen, and the election campaigning conducted to date, opinion polls have barely moved, continuing to show the Labour Party holding an approximate 20% lead over the Conservative Party. Accordingly, a Labour victory has been expected for so long it is now virtually fully priced in, in turn removing much of the volatility normally associated with election results. And even though opinion polls can be wrong, the fact they have remained so static for so long has largely seen this risk removed. This sanguine attitude can be seen in the options markets, where short-dated cable options expiring on Friday are implying an expected move in the pair of only around 60 pips over the next 24 hours or so, approximately twice the daily average move, but significantly lower than the 220 pips that was expected around the last general election in 2019.

Second, it is a question of economics. The parlous state of the UK finances, with public borrowing approaching 100% of GDP and a tax burden that is the highest since the second World War, means that the next government, be it Conservative or Labour, has very little room to pursue policies that will result in a significant increase in public spending. Even though the Labour Party has traditionally been the party of higher spending, higher taxes and higher borrowing, the ability to significantly raise taxes or borrowing now in order to boost spending is simply not there: the lessons of the previous Liz Truss government remain fresh in the memory and continue to scream the need for fiscal responsibility.

Third, the Labour Party has been proactive in trying to reassure the markets that it understands the current economic reality, by setting out the three key planks that will form the backbone of its economic plans.

• Current fiscal rule to remain in place

Perhaps key to maintaining the confidence of the markets has been Labour's commitment to largely match the fiscal rule of the current Conservative Chancellor, Jeremy Hunt. Specifically, the current budget deficit – borrowing excluding investment – will be restricted to 3% of GDP, with the debt-to-GDP ratio to be also falling in five-year’s time. This is slightly looser than Hunt’s rule, which restricts the total budget deficit. But it is nonetheless a major change for a Labour government, giving it the same limited fiscal headroom as the current government, and reassuring the markets that government spending will not be drastically increased under a Labour administration.

• A programme of supply-side reforms

In addition to maintaining tight control of the public finances, Labour is also proposing a series of key supply-side reforms. Firstly, they have pledged to maintain independence for the Bank of England (BoE), to strengthen the oversight role of the Office for Budget Responsibility, to cap the rate of corporation tax at 25%, and have promised a ‘road map’ for the taxation of businesses going forward. The key take-aways of these commitments are that market expectations of interest rates have remained largely unchanged, with no risk seen of political interference in the monetary policy decision making process, and that the ‘anti-business’ fears normally associated with a Labour government have been to a degree assuaged. Second, they will aim to stimulate private investment via a reform of planning regulations, a more interventionist industrial strategy, and through efforts to ‘crowd-in’ private sector investment alongside government investment. And third, workers’ rights are to be expanded, with many of the labour laws brought in by the Conservative government repealed and workers’ rights to holiday- and sick pay expanded, alongside measures to bring down the number of workers who have still not rejoined the work force post-covid, mainly due to health reasons.

Increasing workers’ rights and adopting a more interventionist industrial strategy would normally be poorly received by the markets. However, the reality is that it may take some years for these things to materialise and impact the economy. In the meantime, committing to BoE independence and a top rate of corporation tax are market-friendly measures that will have an immediate impact.

• Improving relations with the EU

A straightforward way to boost UK growth would be to improve the somewhat torturous trading relationship the UK has with the EU post-Brexit, which is now mired by increased bureaucracy and red tape. Some estimates suggest these frictions to trade have eroded UK output by as much as 5%. Accordingly, restoring this trade would provide an instantaneous boost to economic growth. Labour have said they will improve trade relations with the EU and move back more closely to the situation that existed pre-Brexit.

In practice, they are unlikely to get very far with this policy. The EU is very unlikely to agree to an improved trading relationship in the absence of the UK re-joining the EU Customs Union or Single Market, something Labour has so far ruled out. And the EU the Labour Party would be dealing with is a very different EU to that which existed at the time of Brexit. A better policy would probably be to focus attention on improving trading relationships with the rest of the world.

WHAT CAN WE EXPECT POST-ELECTION?

In light of the above, therefore, and assuming we do indeed get the expected Labour Party victory, what can the markets expect going forward?

1. Taxes almost certain to rise – and likely to be higher under Labour

Whichever party wins the election, taxes look certain to rise. Under current spending plans, a majority of government departments are facing real-term spending cuts over the next five years. Overall real-term spending is projected to rise by 1%. However, with the budgets for the health, defence and education departments ‘ring-fenced’, this means spending in other departments will need to fall by close to 2.5% if the limit on overall spending is not to be breached. Such a scenario looks politically unacceptable, particularly given that public services are already creaking and over-stretched. Accordingly, regardless of which party wins the election, an increase in taxes and/or borrowing looks unavoidable, leaving virtually no room for spending on new policies.

The main differences between the Conservatives and Labour, then, are likely to be when taxes rise, and by how much. While government policies would remain largely unchanged under a Conservative government, a new Labour administration will have pet projects that it will wish to implement regardless, even if the latitude for doing so is only modest. Accordingly, a Labour government will probably need to raise taxes sooner than might otherwise have been the case, but by only a relatively modest higher amount if a clash with the markets is to be avoided.

2. Wealth and asset taxes to be targeted

Labour has already ruled out increasing income tax, national insurance contributions or the rate of VAT. These are the main sources of revenue for government. Accordingly, any tax rises will need to be targeted on wealth and assets. These would include the already announced removal of the VAT exemption on school fees in the private sector, a likely increase in capital gains and inheritance tax, or by other measures such as reducing the tax-friendly benefits of saving into pension funds etc. Such moves potentially represent a risk to the competitiveness of investing in UK stocks and shares to discouraging saving for retirement and placing a larger burden on the provide for people in their old age.

3. Main risk for markets to be the forthcoming Autumn Statement

A new Labour government will want to quickly put the flesh onto its economic strategy and the first opportunity for it to do this will be the Autumn Statement, normally held in November but potentially able to be called at any time. When this is delivered, the markets will discover exactly what Labour’s plans are for spending, taxes and borrowing, and whether its pre-election commitment to fiscal prudence is nothing more than just a paper promise or not - given the history of Labour Chancellor’s, the risk of a more profligate fiscal policy than promised is certainly real. As such, the market uncertainty and volatility missing from this election may not have actually disappeared, but rather have instead been delayed to the Autumn Statement. Accordingly, the market may be doing the sensible thing in keeping its gunpower dry now in anticipation of more turbulent times to come.