Frederik Repton, senior portfolio manager with the global fixed income and currency management teams at Neuberger Berman, shares the following analysis on the implications politics could have on financial markets.
The upcoming election has implications that we believe could shape British politics and financial markets for years to come.
When Prime Minister Rishi Sunak stood in the rain outside 10 Downing Street and announced the snap election to be held this July 4, few were under the illusion that any campaign would change the fortunes of the Conservative Party. Since the mini-budget debacle of former Prime Minister Liz Truss, a significant gap in polling has opened up between the Labour and Conservative parties. For this reason, we expect Labour to win a majority in Parliament and that Keir Starmer will become prime minister. However, despite the likely overall result, there are aspects to the election that we believe will shape British politics and financial markets for years to come.
It’s possible, for example, that Labour could command a large majority without an organised opposition as Conservatives lose ground to both the Reform UK and Liberal Democrat parties, neither of which may be inclined to cooperate on alternative policy. Moreover, while many new Labour MPs will owe their seats to Starmer, there will not be enough positions to please everyone; eventually, we believe that discipline will deteriorate, and that the different factions of the party will become more apparent as left-leaning and environmentally focused MPs looking to force through their signature policies.
That, in turn, could affect the fiscal picture. While its wiggle room is limited, we believe Labour will want to enact many of its key policies. So, although its first budget may be viewed as responsible, over time, fiscal largesse could become an issue – in part because of the already large debt burden, but also because the revenue generation of some policies may prove disappointing, even as spending cuts remain difficult.
The timing of the election has already impacted the Bank of England, with its members cancelling all their speeches through election day. This has led markets to dismiss the potential for a rate cut in June. Moreover, the central bank may want to incorporate the new budget into its forecasts before starting to cut rates, creating the risk that such cuts could start too late and be more aggressive than otherwise would be needed.
Initially, we expect UK assets and sentiment to react positively to a political changing of the guard, which could strengthen the British pound. However, over time, we believe that investors are likely to become more concerned about the fiscal deficit, as in other developed economies, potentially increasing the term premium in the gilt market.
