The election result was widely predicted, so the market reaction was muted but positive.
The pound strengthened slightly, to nearly $1.28. The FTSE 100 opened modestly higher at 8,260, with the more domestically focused FTSE 250 outpacing the more international blue-chip index. Gilts were steady, with the 10-year yield around 4.2%.
Here we review the likely implications of a Labour government which will enjoy the largest majority since Tony Blair’s victory in 1997.
Macroeconomics
We think the election result will be supportive of growth in the UK economy over time. Labour has made growth and improved productivity a priority. It is also expected to pursue a more collaborative and constructive relationship with the EU, which could lead to smoother trade negotiations, reduced tariffs and more predictable regulation.
Business investment should benefit from the more stable political environment. The government has signalled its commitment to fiscal responsibility and a cautious approach to tax increases in the short term.
Greater stability should lead to the UK being a more attractive destination for foreign investment.
Although the new government inherits significant economic challenges, including high public sector debts and low growth, other elements of the macro backdrop are more encouraging. The inflation picture is positive, and the Bank of England should be able to begin its rate cutting cycle before long, perhaps as soon as August.
Shares
In the long run, stock markets are not significantly influenced by elections. Our analysis covering the past 60 years of electoral history shows the best periods for the UK stock market have been equally shared between Labour and Conservative parliaments.
UK shares should benefit from greater political stability, which will focus attention on the relatively attractive valuation of the UK market. Stock markets tend to perform better when a government is able to operate with the security of a sizeable parliamentary majority.
At the sector level, there are some important considerations.
Labour’s plans to increase the rate of housebuilding to 300,000 new homes a year is a positive for the construction sectors. The rate of housebuilding has dropped considerably since the 1980s. Last year only 231,000 homes were built. Progress will not be immediate, however, given the complexity of the UK’s planning system.
A commitment to increase defence spending to 2.5% of GDP is a positive for the aerospace sector.
Labour’s commitment to supporting economic growth means it is likely to look favourably on banks, viewing them as a source of investment and lending to the economy rather than an easy target to be regulated and taxed.
Utilities will be in focus, given well-publicised issues with the water companies in recent years. However, the need to invest in nuclear and renewable energy will likely temper restrictions on dividend payments and executive remuneration. Labour is committed to speeding up the transition to renewable energy, a positive for infrastructure spending.
The commitment to remove the North Sea investment allowance is a negative for the oil and gas sector.
Priced at just 11.5 times expected earnings, the UK stock market is relatively attractive compared to its counterparts in Europe, Asia and the US.
Bonds
We expect the election result to have only a limited impact on the gilt market. Both Labour and the Conservatives had refrained from expansive fiscal promises so there was little to upset the bond market and investors seem relaxed about Labour’s willingness to borrow to invest if it results in improved economic growth.
The key factor will be the future path of interest rates. With the election out of the way, attention will turn to the data and with inflation continuing to moderate, the Bank of England should begin to cut interest rates soon. Corporate bonds are less attractive than government bonds as they offer investors a relatively small yield premium to compensate them for the greater risk of lending to companies as opposed to the government.
Your money
Labour’s pledge to avoid raising income tax, national insurance and VAT, coupled with the widespread view that the tax take will have to rise in due course, has renewed speculation about other taxes that the new government could target. It also remains committed to the previous government’s freezing of income tax bands, resulting in more people being pulled into paying higher rates of tax, so called ‘fiscal drag’.
Capital Gains Tax (CGT) is in focus and Labour has refused to rule out changes. All eyes will be on the autumn budget, which could be held just before the party conference season in September or just after it in October. CGT is currently levied at a lower rate than income tax and alignment of the two is a possibility. Labour has ruled out levying CGT on the sale of primary residences.
When it comes to pensions, Labour has abandoned previous plans to reintroduce the pensions lifetime allowance and it has restated its commitment to the existing tax-free lump sum rules. The new Chancellor Rachel Reeves has previously proposed a flat rate of 33% on pensions tax relief but now says there are ‘no plans’ to introduce this measure. The government is expected to conduct a wide-ranging review of the pensions landscape as part of a bid to increase investment in UK markets.
On inheritance tax, Labour’s manifesto proposed scrapping the use of offshore trusts to avoid IHT and there is speculation that it is drawing up options to reform or scrap rules allowing relief on the inheritance of agricultural land and family businesses.
Labour’s manifesto confirmed crackdowns on tax avoidance and non-doms and changes to tax on private schools.
Once the new government is formed, attention will turn to the King’s Speech on 17 July which will set out Labour’s plans for the year ahead.
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