UK election: new government, old problems?

Since 22 May, when UK Prime Minister Rishi Sunak called a General Election for 4 July, polls have pointed to a change of government, with the incumbent Conservative party, sharing power as part of a coalition in 2010 but then winning an outright majority in 2015, expected to lose to the Labour party.

This morning the electorate has duly delivered that change of government, with results showing a large win for the Labour Party, securing them a sizeable majority. On the results so far, as at 8am on Friday 5 July, Labour has won 410 out of 650 seats, a substantial majority of 170 (source: BBC, with eight seats left to declare). In theory, such a majority would allow it to implement a sweeping set of economic policies. Will it? We asked for the views of four of our investment experts.

The economic view – Melanie Baker, Senior Economist

From an economic policy perspective, things should become clearer after the first Budget of the new government. For now, Labour have signalled strong support for Bank of England independence and their manifesto did not signal a big change in fiscal stance in the near term compared to previous government plans. They have promised a change to the fiscal rules, but one that would see a return to an earlier iteration where they target a current budget deficit (so called day-to-day spending) of 0% rather than an overall budget deficit (which also includes investment) of 3% (as is the case at the moment).

That does not mean that there aren’t significant challenges ahead. The tax take, or tax revenue as a percentage of GDP, is already at high levels. Despite which, significant parts of the public sector are under visible strain. It is difficult to see the new government meeting public expectations of, and political promises around, public service delivery at the same time as matching current (tight) government plans for future departmental spending, while not raising taxes and or breaking the fiscal rules.

Growth is key

If nominal growth is strong, then these problems ease, but boosting sustainable economic growth is easier said than done. Labour’s plans, for example, around planning reform, industrial strategy and revisiting the UK’s relationship with the EU could conceivably boost growth, but all come with challenges and may see little economic impact in the short-term.

Labour inherits persistent challenges around UK productivity and long-run growth potential against what looks set to be a challenging global backdrop – from geopolitical threats to climate change. The size of Labour’s majority in theory gives the new government plenty of leeway to change policy in their priority areas, but that doesn’t mean that the going will be easy.

Against a backdrop of political uncertainty beyond the UK, it will also be important to watch the policy direction of the UK’s opposition parties. A swing towards populism, for example could have implications for the long-term direction of UK policymaking, inflation and markets over future election cycles.

The asset allocator view – Trevor Greetham, Head of Multi Asset

Markets aren’t hugely interested in the UK General Election but policy choices over the next few years will be critical with investors likely to face further bouts of inflation.

In contrast to the situation in France, the outcome of the snap election in Britain was never really in doubt and macroeconomic policy differences between the main parties are, on the surface, minor. It’s a world away from 2019 when Boris Johnson faced up against Jeremy Corbyn with Brexit in the balance.

Labour has inherited an unrealistically tight fiscal baseline for departmental spending and their manifesto offers little insight into how they will improve public services without a further substantial rise in taxes and/or debt, both already at a half century high as a share of GDP. Keir Starmer has proposed various measures to boost economic growth, which are welcome, but meaningful improvement may prove elusive if he sticks to his promise to keep Britain outside the EU Single Market and Customs Union, or a ‘Hard Brexit’ in 2019 parlance.

Inflationary pressures may rise

Meanwhile, the battle against inflation is by no means won and an uncertain geopolitical backdrop, populism and a drop in fossil fuel capacity as we transition to net zero all point to further cost of living surges in coming years. If these are seen as ‘just’ spikes, the Bank of England is likely to accommodate them and unanticipated inflation could help Labour with their fiscal conundrum by pushing incomes above tax thresholds and debasing the real value of government debt.

What I set out here would merely be a continuation of the way UK policymakers have responded to shocks over the last 20 years, from the Global Financial Crisis and Brexit to Covid and the Ukraine invasion. In every case, inflation was allowed to overshoot in order to avoid even more painful choices. This is why, as multi asset investors, we believe it makes sense to invest across a broad range of asset classes, including the likes of commodities that can rise in price when inflation hits.

The bond investor view – Jonathan Platt, Head of Fixed Income, and Craig Inches, Head of Rates & Cash

Labour has achieved a huge majority, on a similar scale to Tony Blair's victory in 1997. The opposition is fragmented. How will this affect fixed income markets? The reaction has been calm with the 10-year gilt yield at 4.2%, perhaps reflecting the sense of foregone conclusion. Since the General Election was called in late May, the 10-year gilt yield, sterling, and the yield spread of gilts to other major bond markets have not changed much. Investors seemed certain of the outcome and have been reassured by the fiscal stance as set out in the Labour Party’s manifesto. However, we do not know how Labour's fiscal plans will evolve as they face the reality of the economic situation and in turn, how this will influence gilt supply.

Gilt markets – the approach matters

There are some positives for the incoming government: inflation is likely to fall below 2% later in the year, growth trends are being revised up and interest rates are likely to come down, thereby reducing debt costs. Indeed, when compared with our European peers our overall debt level is not an outlier. Our problem remains one of productivity, particularly in the public sector. This may be an area that a Labour government can more readily address.

The new government will not repeat the mistakes of Liz Truss. However, with a promise not to increase the ‘big three’ taxes (income tax, national insurance and VAT), it is hard to see how Labour can deliver their spending commitment on the NHS and welfare without squeezing other, non-ring-fenced, areas beyond breaking point. There is a chance that in her first Autumn statement the new Chancellor, Rachel Reeves, could be looking to the gilt market for some extra money. We think that the message will be that any fiscal expansion will be for growth purposes, but it will be better articulated than the ‘going for growth through tax cuts’ message unveiled in 2022. Let’s hope investors see the difference.

Looking at government bond strategy, we favour a longer duration than benchmarks, reflecting our view that interest rates and yields will come down on a global basis, rather than this being a specific UK view. Yield curves are expected to steepen as more supply increases term premia. We like areas such as long-dated US inflation bonds and conventional Australian government bonds but we do not favour UK index linked bonds as the implied breakeven inflation rate looks too high, given the move away from RPI to CPI in the medium term.

Credit markets – impact is more sector specific

The expected impact on credit markets is minimal. Some sectors, such as utilities, will face more scrutiny, but the government will have the same dilemma: who will pay for the massive capital spending needed to upgrade our infrastructure. Private capital will require an economic return and if this is not possible then the taxpayer will have to intervene. In either case, customer bills may have to increase to fund, for example, water infrastructure upgrades and to help the shift to net zero. UK banks could be relatively worse off, as the government may try to lower the interest earned on deposits at the Bank of England but capital ratios are strong; we are positive on the bank sector in our sterling credit strategies and expect to remain so.

Taking a more global view, UK assets may benefit from a period of political stability, especially as the euro area political landscape looks more uncertain and the potential change of direction after the US Presidential election in November. A key imperative for the UK is that markets are comfortable that any government will spend our money wisely, promoting productivity, a healthier workforce and improved trade relationships.

The mutuality view – Steven Hill, Royal London Head of Policy and External Affairs

Labour’s manifesto contained a commitment that did not generate many media headlines, but which could make an important contribution to the incoming Government’s central ambition to grow the UK economy.

Page 35 of the document states that Labour will aim to “double the size of the UK’s co-operative and mutuals sector“ and “work with the sector to address the barriers they face, such as accessing finance”.

As the UK’s largest mutual life, pensions and investment company, Royal London strongly supports the Labour government’s ambitions in this area. Over the past couple of years, we have been working with policymakers across all the main parties to increase the profile and understanding of the sector.

In financial services, mutuals are unique, in that the company can share its profits with its customers who own the business. This does not make it inherently better than any other model, but it does make it different. At Royal London, for example, since 2007 we have paid more than £1.7 billion directly into member pension pots through our Profit Share scheme, including £163 million in 2023.

Shareholder-owned businesses have much to offer and form the very bedrock of capital markets which have served the UK so well in its development over the years. This is about enabling mutual companies to compete on a level playing field with other business models and, crucially, ensuring there is a strong mutuals sector in the UK that benefits consumers by delivering greater choice and competition.

In many developed economies, including several European countries, Australia, Canada, and the United States, mutuals form 30, 40 or even 50 per cent of the market. The UK used to have a large mutual sector in financial services, but many companies demutualised in recent decades, resulting in mutuals comprising less than 10% of the overall market. Given UK mutuals and co-operatives have a combined annual income of over £87 billion, failing to help them grow further represents a missed opportunity for the UK economy.

There were signs in the latter stages of the previous government that policymakers were beginning to consider the benefits of a stronger mutuals sector. But few would dispute that the election of a Labour administration, with a specific target to double the sector, has the potential to be a significant milestone in the long history of mutuals.

The new Government could send an immediate and important signal about its ambitions for the sector by appointing, in the coming days, a Minister for Mutuals. By explicitly including mutuals in a minister’s responsibilities, the civil service support system for the sector would immediately be upgraded and ensure mutuals were a critical part of the decision-making process within government across business and economic policy.  

At a time when the public’s appetite for companies to act and behave more responsibly has arguably never been greater, equally, the case for a corporate model which focuses on the long-term interests of its customers, and shares the proceeds of growth with its members, has arguably rarely been stronger. The next few years could be hugely consequential in policy terms for mutuals and Royal London will continue to work with policymakers to support the growth of the sector.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.