UK election: Making sense of the decision

With a UK election called for 4 July, Guy Foster, Chief Strategist and Paul Danis, Head of Asset Allocation Research, consider the reasons behind the decision and the potential impacts for investors.

It was always likely that an election would be called this year. It was just a matter of when.

Theoretically, an election could have been held very early next year but that would have required campaigning over Christmas (not something voters would have appreciated).

The working assumption had been that the election would take place in November, relatively late in the year but without interfering with the festivities. The Budget in March seemed to leave the path open to that, with the possible scope for further tax cuts to follow the two recent cuts to National Insurance which have been effective this year.

However, since then there have been a few economic reasons to consider an earlier election.

The economic rationale for a July election

The most obvious reason for calling for a July election is the inflation rate announced yesterday morning.

The figures showed a relatively sharp decline in the inflation rate, from 3.2% to 2.3%. This bookends a period where the UK, which suffered unfortunately high inflation rates for many months, has seen a significant improvement in inflation figures (it peaked at more than 11% in late 2022 and was still nearly 9% a year ago).

Without going into too much detail about how inflation forecasting works, we could be confident in the slowdown announced yesterday and there is a good chance that a further decrease will be announced between now and election day. Thereafter, there will be less to gain.

In fact, some of the detail from yesterday’s report might even give policymakers cause to worry about lingering inflationary pressure, like that seen in the U.S. this year.

In April, the Office for National Statistics announced UK government borrowing figures which were worse than that predicted by the Office of Budget Responsibility (OBR) — the body which scrutinises tax and spending activity to shine a light on the sustainability of the country’s borrowing.

More figures were announced yesterday, and they have deteriorated again.

The OBR will need to take account of compensation payments due in respect of the NHS contaminated blood scandal as these become sufficiently certain. That limits the scope for further tax cuts later in the year.

The UK’s economic growth since the start of 2024 has been relatively buoyant, bouncing back from a technical recession in the second half of 2023. Unemployment is relatively low but jobs growth has been slowing, so there is more scope for joblessness to rise than decline.

So, overall, the economic backdrop for a 2024 election might not get much better than this.

Of course, there are many non-economic factors to consider. These include the success of the government’s new immigration policy and the challenges of fielding candidates with a relatively large number of retirements and a few defections from sitting MPs. However, from the release of April’s government borrowing statistics onwards, the case for an early election has been building.

Whilst the rationale for an early election may exist, it doesn’t mean the government will prevail. Indeed, according to polling and election forecasters a substantial Labour majority seems virtually inevitable.

Both parties will be working on their manifestos, and the changing state of the public finances will complicate their efforts, but what do we know about their differences and what do they hope to change?

The dividing lines between the Conservatives and Labour

The Labour party has outlined a host of solutions to the problems it believes are holding back the British economy. Among these include planning reform, better EU relations, a plan to ramp up public investment with its Green Prosperity Plan and plans to strengthen worker rights. Labour would also look to allocate more funds to the NHS, schools, and childcare, while spending more on policing and ramping up border security to tackle illegal migration.

Labour has outlined several revenue raising measures to pay for all of this. Among these is a planned crackdown on tax dodgers, the increasing of the energy tax levy, and going further with reforms to the non-dom regime already announced by Jeremy Hunt in the Spring Budget.

The party has also promised to abolish the carried interest “loophole”, charge VAT on private school fees and end private schools’ business rates exemption.

Importantly, Labour said it will keep corporation tax unchanged at the current 25% for the duration of its potential tenure. Neither will there be an increase to the top rate of income tax or capital gains tax.

In response, last Friday, Chancellor Jeremy Hunt released a dossier put together by the Treasury that attempts to summarise Labour’s ‘revenue raisers’ and spending commitments. In short, the Treasury calculates that Labour spending over the next four years would amount to £58.9 billion, but their revenue raisers would bring in only £20.4 billion.

Hunt said the result is a “black hole” of £38.5 billion pounds, or almost £10 billion per year. However, it’s hard to know how accurate these claims are given the level of uncertainty involved, and it’s perhaps unsurprising that these claims are coming from the opposing party to Labour.

That being said, there are others who also see a gap. Many economists believe that additional tax rises under Labour would be inevitable.

Of course, tax rises are not the only way that a government can fund spending — it can also increase borrowing. But Rachel Reeves promises to strengthen the role of the OBR with a new fiscal lock.

At any rate, even if Labour wanted to fund its spending via deficits, the current fiscal reality will likely make it wary of doing so outside of a crisis.

Based on current law, the overall government deficit is projected to remain sizeable due in large to high government interest expenses. The OBR baseline scenario sees UK government debt to GDP rising to 300% by the year 2070 if current law remains unchanged. Given how far in the future this is, it’s impossible to have any precision with these projections. But the direction of travel is clear. Concerns about government finances are not going away, and so will remain on the front burner for policymakers for the foreseeable.

Impact on UK markets

With domestic uncertainty ahead for at least the next six weeks or so, the UK economic outlook will be an important driver of performance for its equity market.

However, global developments will likely overshadow domestic activity given how internationally exposed the UK market is.

The UK equity market has outperformed of late. This has been due to strong performance in sectors the UK market is relatively heavily weighted in, such as miners, energy, and banks.

And there is room for growth given the bright outlook for spending on artificial intelligence. Taken together with UK equities trading at relatively low values, and there’s probably scope for continued modest gains under Labour as global equities rise. But equally, the election is not a reason to believe the UK will shine particularly brightly relative to other equities markets.

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