background image background image background image

UK Elections: Markets May Be Too Complacent

Macro 5 minutes to read
Charu Chanana 400x400
Charu Chanana

Head of FX Strategy

Key points:

  • The July 4 UK elections is tilting in favor of a likely Labour majority, after a 14-year Conservative rule characterized by Brexit and the cost-of-living crisis.
  • With limited fiscal space, Labour is expected to focus on supply-side reforms and cautious fiscal policies, likely promoting long-term economic growth and stability.
  • Markets remain complacent with policy stability remaining the base case. UK assets have also attracted some safe-haven flows amid the election risks elsewhere in the US and Europe.
  • UK’s stock index FTSE 100 still trades at a significant valuation discount to global stocks, and offers a good dividend yield as well as scope for portfolio diversification.
  • Sterling could face short-term volatility if Labour’s victory is not as strong as anticipated, and if the Bank of England adopts a dovish stance post-election. However, long-term support for GBP may persist against the EUR due to contrasting political and fiscal stability between the UK and the Eurozone.

 

The UK is gearing up for another significant election on 4 July 2024. The political landscape has been shaped by key events such as Brexit and the pandemic, which have left lasting impacts on the nation's priorities. Currently, the political climate is charged with debates over economic policies, healthcare, immigration, and climate change. The main political parties are putting forth their platforms, each aiming to address these critical issues.

Labour maintains a commanding lead of over 20% against the Conservatives. Prime Minister Sunak's Conservative Party has struggled to gain traction, with some of their supporters shifting to Nigel Farage's Reform Party. This shift has allowed Labour to secure a substantial double-digit lead in the polls.

28_FX_UK polls
Source: Bloomberg

Lack of Fiscal Firepower

Drawing parallels to the 1997 election, when Tony Blair and his Chancellor of the Exchequer Gordon Brown emphasized fiscal prudence in the early years, is relevant. More recently, Liz Truss’s short and tumultuous tenure as prime minister highlighted how bond markets can effectively curtail politicians' fiscal ambitions.

The Labour manifesto lacks radical spending plans, suggesting that its leader, Keir Starmer, and his shadow finance minister, Rachel Reeves will likely maintain fiscal conservatism with debt levels running high.

 

What Can Labour Majority Mean for the Economy?

A potential Labour majority in the upcoming election could mark the end of a 14-year Conservative rule characterized by Brexit and the cost-of-living crisis. However, with limited fiscal room to maneuver, immediate changes may be modest even with a Labour majority.

Nevertheless, signs suggest the UK economy is stabilizing following a brief recession last year. Forward-looking indicators such as the Purchasing Managers’ Index (PMI) and consumer confidence are improving, while monthly GDP shows positive trends. Although services inflation remains high, easing goods inflation is lowering headline inflation, possibly prompting the Bank of England to consider cutting interest rates, possibly earlier than the US Federal Reserve.

A stable policy stance under a Labour government would likely sustain this economic trajectory, bolstered by long-term tailwinds. With immediate fiscal options constrained, the focus is expected to shift towards supply-side reforms, potentially supporting the UK economy's recovery from Brexit over the long term. Labour may also aim to reduce some post-Brexit trade barriers, reflecting its stance on improving relations with the EU, though such changes would likely take time to materialize. Additionally, Labour plans to increase investments in green projects.

A more commanding lead for the Labour party could, however, leave room for some bold policy moves. The economy remains in need for more significant tax increases to keep its fiscal position sustainable, but significant tax increases may be avoided in the short-run.

 

UK Equities: Structural Tailwinds

The anticipation of a stable political and policy landscape has kept UK markets resilient amid election uncertainties. Any potential market retreat could present a favorable opportunity to position for the UK economy's ongoing rebound from the challenges of Brexit, Covid-19, the Russia-Ukraine conflict, and the instability under Liz Truss's government, which triggered significant outflows from equities and bonds.

The UK markets are also seeing some safe-haven flows amid the election risks elsewhere in the US and Europe. A favourable policy environment, along with the potential for BOE rate cuts, may offer investors an opportunity to reassess UK equities, where valuations are attractive and return prospects look strong.

The following factors could be key for long-term investors:

  • Valuation discount: This has led to MSCI UK trading at a significant discount to MSCI World or other developed markets ex-US as reflected by the MSCI EAFE index.
  • High dividend: UK equities offer the highest dividend yield among all the key markets
  • Sector composition: The index has a balanced mix of defensive and commodity exposures. While oil and gas companies could feel some pain from the Labour’s green transition plan, they still remain a good hedge against geopolitical risks.
  • Low beta: UK equities have a low beta to global equities, suggesting they can enhance portfolio diversification.
  • Domestic focus: The FTSE 250 Index has a more domestic focus compared to the FTSE 100. The FTSE 250 comprises mid-cap companies that are generally more oriented towards the UK economy, making it more reflective of domestic economic conditions. In contrast, the FTSE 100 is made up of larger companies that tend to have significant international exposure.
28_FX_MSCI UK
Source: Bloomberg. Note: Past performance does not guarantee future performance.

GBP: Threat of ‘Buy the Rumour, Sell the Fact’

Sterling has been the top performer in the G10 FX space due to a stabilizing economy, high yield, the Bank of England's lack of urgency to cut rates, and expectations of political stability. However, this sense of complacency might be challenged if Labour's victory isn't as strong as anticipated. Notably, the Reform UK party has been gaining in the polls. A weaker Labour majority could lead to the market demanding a higher risk premium for UK assets.

Sterling could also face risks if the market's reaction follows a "buy the rumour, sell the fact" pattern post-election. Additionally, there are downside risks for GBP if the Bank of England adopts a more dovish tone in the weeks following the election as the central bank paves the way for its first rate cut.

However, GBP may have room to stay supported against the EUR, particularly if election outcomes in France and UK remain divergent. UK’s political and fiscal stability comes in a stark contrast with unstable dynamics in the Eurozone, suggesting that the path of least resistance for EURGBP in the medium-term could be lower.

28_FX_EURGBP
Source: Bloomberg. Disclaimer: Past performance does not indicate future performance.

Disclaimer:  

Forex, or FX, involves trading one currency such as the US dollar or Euro for another at an agreed exchange rate. While the forex market is the world’s largest market with round-the-clock trading, it is highly speculative, and you should understand the risks involved.

FX are complex instruments and come with a high risk of losing money rapidly due to leverage. 65% of retail investor accounts lose money when trading FX with this provider. You should consider whether you understand how FX work and whether you can afford to take the high risk of losing your money.

Recent FX articles and podcasts:

    Recent Macro articles and podcasts:

    Weekly FX Chartbooks:

    FX 101 Series:

    Quarterly Outlook 2024 Q3

    Sandcastle economics

    01 / 05

    • 350x200 peter

      Macro: Sandcastle economics

      Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

      Read article
    • 350x200 althea

      Bonds: What to do until inflation stabilises

      Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

      Read article
    • 350x200 peter

      Equities: Are we blowing bubbles again

      Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

      Read article
    • 350x200 charu (1)

      FX: Risk-on currencies to surge against havens

      Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

      Read article
    • 350x200 ole

      Commodities: Energy and grains in focus as metals pause

      Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

      Read article

    Disclaimer

    The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

    Please read our disclaimers:
    Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
    Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
    Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

    Saxo Bank A/S (Headquarters)
    Philip Heymans Alle 15
    2900
    Hellerup
    Denmark

    Contact Saxo

    Select region

    International
    International

    Trade responsibly
    All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

    This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

    Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.