What Prime Minister Corbyn would do to the British economy

Erik Norland
New Scottish Labour Leader Richard Leonard Gives Keynote Speech To Party Activists In Glasgow
We could see Britain transform into a more socialist, centrally-controlled economy – just one that happens to be outside the EU (Source: Getty)

Since losing its parliamentary majority in June, Theresa May’s coalition government has been hanging by a thread.

Even under the best of circumstances, keeping its grip on power would be difficult given stalling Brexit negotiations and inner turmoil within the cabinet.

Considering this fragility, investors should be thinking carefully about the next Prime Minister. In fact, even if things in Westminster were going swimmingly markets, should still be looking to the next elections anyway.

Read more: Corbyn says it's "no wonder" bankers are running scared from the UK

Turning tides

UK voters have a way of turning against incumbents. In the last 26 elections, the incumbent party or sitting coalition have only expanded their popular vote margin five times, losing support the other 21.

On average, the opposition have achieved a swing of at least six per cent, something that the Tories can ill afford given that they only won the 2017 elections with a margin of 2.4 per cent.

Indeed, the Labour party has moved into a small but consistent polling lead since July. When new elections take place, they could easily produce a Labour majority or a hung Parliament.

While the elections don’t have to take place until 2022, there are numerous scenarios under which they could be hastened which is good news for Jeremy Corbyn who stands to become Prime Minister should Labour win.

Not New Labour

In 2002, a dozen years after she left office, Margaret Thatcher said that her proudest accomplishment was New Labour and Tony Blair.

Under Blair, budget deficits were negligible, income tax rates stable, government spending grew at a moderate pace, regulation had a light touch, and the pound was reasonably strong.

That was then.

Corbyn’s policies on the other hand, including advocacy of higher income taxes, authorisation of the Bank of England to directly finance infrastructure spending, and expansion of public spending, are unlikely to support the pound.

The Brexit-Corbyn Nexus

One of the key arguments from Conservative supporters in favour of Brexit was that it would allow the UK to become more like Switzerland with low taxes and light-touch regulation.

This will not be the case if Corbyn wins.

In the event of a hard Brexit followed by a Labour victory, we could see Britain transform into a more socialist, centrally-controlled economy – just one that happens to be outside the European Union.

This would be a nightmare scenario for the pound.

Since late September, sterling has already fallen 4.5 per cent versus the dollar and slightly versus the euro as Brexit talks stall and May’s position weakens.

If events spiral beyond the Prime Minister’s control and Brexit talks are further paralysed, this will likely intensify continued downward pressure on sterling.

Changing course

Another possibility facing the UK is that the Tory government collapses and Labour comes to power prior to March 2019 when Brexit negotiations are due to conclude.

Changing negotiators mid-course could be bearish for the pound in the short term, but if for some reason Brexit does not happen, the pound could rally versus the dollar and the euro.

Some strategically minded Tories might even be inclined to foist the Brexit negotiations on Labour in order to benefit from any deterioration in the party’s popularity once Corbyn is in power.

At any rate, it might be easier for the Conservatives to deal with their internal divisions if they were out of power rather than when they are running the country.

Market impact

Whatever course the British government follows in the next few years, markets must be conscious of the potential for volatility in the short term.

To date, it is curious to observe just how complacent options market have been.

Implied volatility on 90-day pound-dollar options recently traded as low as 7.5 per cent. Though not a record low, this figure is much closer to the lower end of the volatility range than the higher side.

Fundamentally, whilst markets aren’t currently predicting volatility the outlook for Theresa May’s government remains precarious. Should Theresa May’s government fall and the keys to Number 10 find their way into Jeremy Corbyn’s hands, volatility will undoubtedly return. Given the current pockets of complacency, markets would then have a rude awakening.

Read more: Unicredit boss brands Brexit "much ado about nothing"

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