General Election Called
Recent data indicates that the UK economy has emerged from recession, and the Consumer Price Index (CPI) is now at 2.3%, approaching its target. This improving economic situation appears one factor in Rishi Sunak’s decision to call a general election. The precise timing may have caught many by surprise, but the parties and the electorate all knew an election was coming this year and therefore the prime minister’s announcement did not cause disruption to investment markets.
While their manifesto has not yet been released, whenever discussing the public finances, Keir Starmer and Rachel Reeves have sought to portray themselves as fiscally prudent. There has been the promise to maintain Jeremy Hunt’s fiscal rule that debt will fall as a percentage of GDP by the end of a five year period. Additionally, they have repeatedly asserted that all Labour’s plans have been ‘fully costed’ and ‘fully funded’. This effort to be considered as business-friendly and market-friendly seems to be working. The FTSE All Share and the UK bond market appear not to have been adversely affected by the prospect of a Labour government so far, and it seems unlikely that a strong victory for Labour would lead to any major market movements.
The Risks of a Hung Parliament
Where this prediction is less certain, is if Labour falls short of current polling expectations, resulting in a hung parliament. Such a result could lead to significant volatility as the shape and likely stability of the government would be uncertain. However, this outcome doesn’t necessarily guarantee political turmoil. The Conservative-Lib Dem coalition government, for instance, provided relative stability compared to the often changing political landscape since that time.
In the short term, if a majority government isn’t formed, losses wouldn’t be unexpected as parties scramble to create a viable coalition. A recent example is the experience of India’s stock market in recent days, which fell nearly 6% after Narendra Modi’s BJP party failed to secure the strong election victory that was expected.
Refocusing on the UK, a stable coalition government may well allow market confidence. However, a weak and unstable arrangement resulting from the election could dampen market sentiment. Under such circumstances, businesses may lack confidence in government policies, potentially discouraging long-term investments and affecting overall economic productivity.
In summary, if the election aligns with current polling, markets are unlikely to suffer adverse effects. However, an indecisive election outcome could still damage investor confidence.
Rate Cut Expectations Drive Market Returns
Moving away from politics, let’s examine the impact of monetary policy on markets. 2024 so far has been a strong year for investors. Developments in Artificial Intelligence have been one factor contributing to this strength, particularly benefiting US markets in the first few weeks of the year. However, since the beginning of February, it has actually been UK and then European equities which have experienced the strongest gains amongst western markets, with Asia (excluding Japan) and the Emerging Market regions leading globally.
The strong performance of the latter can be attributed to China’s improving economic situation and a slight easing of geopolitical tensions. However, in the case of the former, the robust performance is linked to declining inflation and the expectation of interest rate cuts, along with more attractive valuations compared to US markets
Central banks raised interest rates to combat inflation, which reached a multi-decade high in October 2022. But the pace of price rises has fallen since then and with inflation now nearly back to target levels, interest rate cuts are expected over the coming months. While the Bank of England is expected to wait until after the election to adjust interest rates, the European Central Bank (ECB) faces no such political constraint. The European Central Bank (ECB) announced on the 6th June that it was time for the first rate cut.
A Boost to Sentiment
Anticipating lower interest rates, markets have responded positively this year. The ECB’s announcement was largely expected and already factored into share prices. However, as this marks the start of an anticipated easing trend, further positive market impacts are likely. While some economic benefits have already materialised due to rate cut expectations, the full impact is yet to unfold—especially considering that the UK and US have not yet begun lowering interest rates.
News headlines have focused on high inflation, recessionary pressures, and elevated interest rates, leading to poor sentiment among businesses and individuals. As a result, confidence in making significant purchases or long-term commitments has been lacking. Yet, with inflation moving towards target levels, with the UK economy having emerged from recession and with the journey to lower interest rates having commenced in Europe, economic news headlines are likely to become less gloomy. This should contribute to improved sentiment and so to higher levels of spending throughout the economy, which in turn is likely to be a stimulatory factor for investment markets.