Market Volatility Looms as UK Heads to the Polls
The UK will hold its first national election in almost five years on Thursday, July 4, and polls suggest the ruling Conservative Party, led by Prime Minister Rishi Sunak, might lose voters for “failing to deliver on promises”. After 14 years in power, the Tories face a potential defeat, with the Labour Party expected to win by around a 20% margin.
With one day to go until the British head to the ballots, the gap may have narrowed, according to polls, but it still remains around twice as wide as the Tories' 22%, with far-right Reform falling close behind at 16%. Let’s take a closer look at the UK general elections and the possible effects on the markets:
Why Snap Elections
Prime Minister Rishi Sunak called an early election on 23 May in hopes of catching Labour “off guard” ahead of January 2025, but the campaign has faced multiple challenges. The Conservatives have been negatively affected by economic issues like falling real wages, high inflation and record immigration levels under their watch. Net migration has jumped and is almost four times its 2019 level despite government promises to reduce it.
Moreover, Sunak has struggled to connect with voters due to his immense wealth, and a betting scandal involving Conservative candidates has also erupted. The looming defeat comes after a turbulent decade for the Conservatives that saw five prime ministers, Brexit, economic struggles and political scandals.
What Do the Polls Show?
The election results so far show who might win, but the size of the Labour majority and the makeup of the opposition are unpredictable. Many pollsters say the polls would have to be wrong by a huge magnitude for the Conservatives to win a majority, though the number of Conservative seats could end up being lower than anticipated.
Although Labour is expected to win in a landslide, the scale of the Tories' defeat depends on how undecided voters vote - currently at around 12%, with many former Tory voters undecided or planning to vote for Reform UK. If Reform does better than polls suggest, it could cause big changes in seat numbers and make interactions with Parliament, but also with the Eurozone, challenging. At this stage, all calls suggest Reform will win seven seats, compared with the Conservatives' 64 and Labours' 484.
The Labour Party, led by potential new PM Sir Keir Starmer, is ahead in most opinion polls after focusing its campaign on the message of "change." It promised to grow the economy, invest in infrastructure and make the UK a "clean energy superpower". If Labour wins a big majority and the Conservatives lose many seats, it could bring the biggest change in UK politics in decades.
Sunak might have campaigned hard and even insists that the election outcome is still uncertain, but Conservatives have faced struggles and political scandals. However, they insist that Labour would have to raise taxes significantly to implement their agenda, with experts also warning that the coming years may still be challenging for Labour. Nonetheless, traders and citizens alike will have to wait until tomorrow to see the actual results of the elections. (Source: The Wall Street Journal)
How Could the Markets React?
The UK elections may have increased stock market volatility in the short term, but it may have been reduced now as polls showing Labour as a clear winner offer certainty. While there are some correlations between political parties and stock market performance in the UK, the evidence suggests these may be coincidental rather than causal.
Still, back in May, when Sunak announced the surprise elections, the FTSE 100 (UK 100) dropped by 0.3% as markets digested the news. In contrast, the British pound (GBPUSD) gained against the US dollar (DX) as the snap call provided some clarity to the markets. UK’s FTSE 100 index did rise around 5% in June, however, contrary to battered French stocks following President Macron's snap election.
Analysts at JPMorgan (JPM) believe a Labour election victory will be a "net positive" for financial markets. MUFG analysts, a Japanese investment bank, also said that a Labour win could be "most positive for the pound." However, they did note that although it could end political instability, it would raise expectations of higher government spending.
Specific stocks may react to the election outcome depending on Labour's policy announcements and potential impact on the industry and company. For instance, Labour pledged to build 1.5 million houses and upgrade another 5 million in 5 years, increase its green energy investments by £23.7 billion and boost its defence spending to 2.5% of GDP while deciding to expand windfall taxes on oil and gas producers. On the country level, if the ruling party proposes significant tax cuts or "fiscal profligacy", the UK's pound could weaken. Yet, most analysts believe whoever wins the election must show fiscal restraint, and only time will show how this might affect the markets.
The Path Forward
Despite the UK snap election reducing market uncertainty, investors expect the Starmer (if he wins) to announce no major fiscal changes. This has allowed investors to focus on interest rates and the economy, although some volatility is expected around Labour's announcements.
In its last policy decision on 20 June, the BOE kept its interest rate unchanged at 5.25% despite CPI slowing to the target of 2% in May. It said that the timing of the upcoming general election on 4 July was "not relevant" to its decision. However, analysts believe the committee wanted to avoid being seen taking sides during the election campaign. The BOE's decision contrasted with the ECB, which started cutting rates. Nonetheless, UK shop prices fell 0.2% in June, the slowest pace of annual inflation since October 2021, which boosted hopes of interest rate cuts by the BOE.
Falling interest rates are expected to reduce the government's borrowing costs and make UK bonds more attractive, as it would incur smaller interest rate charges on its debt. The UK bond market mini-budget crisis of 2022 caused by the Truss government's tax cut plans appears to still weigh on the market and the upcoming election, with Labour likely inheriting high levels of debt when they come into power.
Some economists have suggested that a "tiered remuneration" policy could save the government over £100 billion by reducing the interest paid on banks' reserves when the UK faces high debt issuance of £278 billion to cover COVID and Ukraine war costs. However, there is a debate on whether the Treasury should continue to provide this indemnity and pay high interest rates to banks for holding reserves. The key question is whether the new Chancellor will be willing to implement this proposal.
Shadow Chancellor of the Exchequer for the Labour Party, Rachel Reeves, wants to give the Office for Budget Responsibility 10 weeks to prepare forecasts before the Labour budget in mid-September, with only immediate decisions and events disrupting Labour plans.
Conclusion
The UK election on 4 July can hold significant implications for the markets as Labour is expected to secure an assertion over the Tories. Investors may want to prepare for potential shifts in policy, although most analysts believe the market reaction will not be substantial given expectations to keep fiscal policy largely unchanged. While short-term volatility is expected, a Labour win is seen as a net positive by analysts with a focus on long-term effects from still unknown changes the potentially new PM will announce. However, these are all projections and only time will reveal what the future holds for the UK and the financial markets.
