In a recent Special Report, our European and geopolitical strategists discussed investment implications of the upcoming U.K. elections.
The U.K. general election is set for May 7, with the outcome too close to call at this point. If we had to put our money on the outcome, we would favor the center-left Labour Party to pull off a tight victory that produced a center-left coalition with either the Liberal Democratic Party (Lib Dems) or the Scottish Nationalist Party (or both).
The election is likely to have only a modest impact on the equity market. The reason is that over time, the U.K. stock market has become a collection of large multinational companies that are listed on the London Stock Exchange but have very little exposure to the U.K. economy or politics. The main driver of the U.K. stock market’s relative performance is its sector skew: overweight Energy; underweight Industrials, rather than domestic economics and politics. Hence, the FTSE100 outperforms when Energy outperforms Industrials and vice-versa.
However, the election outcome will be much more significant for the interest rate and gilt market as well as the pound. A center-left Labour-led government is likely to slow down the pace of austerity. The U.K. has one of the largest budget deficits in the developed world and its fiscal thrust is expected to be deeply negative in the coming years. A Labour-led government, particularly one supported by the more left-leaning SNP, would slow the pace of consolidation. Together with the recent improvements in the labor market, consumer confidence, and real wages, this could force the Bank of England to tighten monetary policy earlier than the market is currently expecting – putting upward pressure on gilt yields and the pound.
Furthermore, a win for the pro-EU Labour government would remove uncertainty over the EU referendum.