TO SAY that the General Election result was a surprise barely does it justice. The markets reacted positively to the news that the Conservatives had gained an overall majority, with sterling surging and the FTSE 250 reaching all-time highs.
There were three reasons for this. First, stocks in sectors that would have faced tougher regulation or taxation regimes under a Labour-led government, including banks, house-builders, estate agents, and energy firms, breathed a sigh of relief as the threat of further intervention was removed. Second, rightly or wrongly, UK markets have a pro-Conservative bias, which can lead to a reaction even if it is not long-lasting. Finally, political uncertainty was removed from the table. The expectation had long been that Britain was due a protracted period of coalition negotiations, and even a second election this year. In that respect, there is now more continuity and certainty for businesses.
It is difficult to say whether the relative narrowness of the Conservatives’ majority in Parliament will undermine the government’s stability over time. Both between 1974 and 1979 and between 1992 and 1997, majorities were eroded through by-election defeats and defections, and that is certainly a risk in this Parliament. And given that there will be a referendum on Britain’s EU membership in the next couple of years, the fact that the Tory Party has a history of tearing itself apart over Europe may be significant.
But more important for the moment is what the new government means for businesses in policy terms. Aside from Scotland, which is likely to receive more powers over tax and spending, there are two major issues to consider.
First, there is the matter of the In/Out referendum on Britain’s EU membership, due to take place by 2017. Currently, it seems sufficiently far away for markets not to be too concerned. In fact, it might not have much of an effect at all. There are a couple of hurdles to climb before investors and businesses have to seriously contemplate the prospect of the UK leaving the European Union. First, public opinion is currently generally in favour of EU membership. Second, there is a real chance that support for the EU will be bolstered by the Prime Minister negotiating successfully with European officials and recommending that the UK should stay in the EU.
There are, of course, question marks over the accuracy of the polls – especially after their failure to correctly predict the result of this election. But they’re all we have to gauge public opinion, and markets will continue to look to them as a guide to the relative likelihood of different referendum results.
Second, there is fiscal policy. We’re due a Spending Review over the next few months, and it looks like this will be preceded by another Budget. There is a theory circulating that the new government will run a tighter fiscal ship than the coalition. We don’t think this will be the case.
In the Budget in March, the chancellor relaxed spending assumptions for 2019-20 so that the government would run a smaller surplus in that fiscal year than previously forecast. The profile implied three years of very tight spending and relaxation in the fourth. What could happen now is that the government averages out those four years to give a smoother profile and less draconian cuts over the next three years. The Conservatives also made several promises during the election campaign – including £8bn of extra spending on the NHS – that were not accounted for in the March Budget. So in the coming Spending Review, spending reductions could be somewhat more modest than the raw figures suggest.
Philip Shaw is chief economist at Investec. This article is provided for information purposes only and should not be construed as advice of any nature. The views and opinions expressed are subject to change without notice.