Election analysis: Stability in UK markets, cautious outlook for the pound

Elections in the United Kingdom are being held on Thursday, July 4, 2024. Polls suggest a Labour Party victory, with a chance to regain power after a 14-year hiatus. As noted by Saxo Bank in its analysis, the pre-election discussion in the media has been dominated by topics such as economic policy, healthcare, immigration, and climate change.

Charu Chanana emphasizes that the Labour Party has a 20% lead over the Conservatives in the polls. "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," she explains.

The Saxo Bank expert highlights the new government's limited budgetary capabilities. "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."

Chanana also notes that the Labour Party's manifesto does not contain radical spending plans, suggesting that its leader, Keir Starmer and Shadow Chancellor Rachel Reeves are likely to continue a conservative fiscal policy given the high level of debt.

According to the author of the analysis, specific signals indicate that the British economy is stabilizing after 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," Saxo Bank reports.

"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," adds Chanana.

The expert predicts that "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."

Saxo Bank notes that forecasts of political stabilization after the elections have made British financial markets appear resilient to electoral fluctuations.

"Any potential market retreat could present a favourable 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 analysis states.

The analyst lists key factors that make British stocks attractive: "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. Low beta coefficient: UK equities have a low beta to global equities, suggesting they can enhance portfolio diversification."

The Saxo Bank expert warns: "The Bank of England seems to lack any urgency in lowering the interest rate, though it is expected to do so gently over the coming months, perhaps to 4.75% by its January policy meeting. However, this sense of complacency might be challenged if Labour's victory isn't as strong as anticipated." Chanana explains: "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."

At the same time, the expert notes: "However, GBP may have room to stay supported against the EUR, particularly if election outcomes in France and the 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."