Senior Schroders economist comments on the election

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Written by: Azad Zangana, Senior European Economist, Schroders
08/05/2015
As results continue to roll in for one of the most unpredictable UK general elections of all time, it appears that the polls were wrong over the closeness of the race for Number 10 and investors are likely to respond positively to the news.

A last minute surge of support for the Conservative party is now expected to lead to an outright majority for David Cameron’s party – an astonishing result and totally unexpected by pollsters and betting markets.

It appears that the polarisation of the parties in the political spectrum has had two effects. The first is the decimation of the centrist Liberal Democrat party as voters moved to either Labour or the Conservatives. The second impact is a shift of floating centrist voters to the Conservatives, as the Labour Party was dragged further to the left (socialist) by the Scottish National Party (SNP), while Cameron held firm. The SNP has made spectacular gains in Scotland at the cost of Labour and the LibDems, which will surely sharpen the divide with the rest of the UK and re-raise the Scottish Independence debate.

For investors, a clear victor removes a tremendous amount of uncertainty in the near-term over the ability of the government to govern and legislate and, as a result, Sterling has bounced by about 1.25% against the U.S. dollar; 2.5% against the Euro, while FTSE 100 futures are trading about 1.7% higher, with strong gains in banking and utility stocks, which were under threat by Labour policy.

In time, the focus of investors will shift to the uncertainty that will come ahead of the proposed referendum on the UK’s membership of the European Union in 2017, which could prompt some domestic and overseas investment to be delayed. Latest polls on the question suggest that those that want to remain in the union have a small lead, but that the majority are undecided.

Otherwise, in the near term, the clarity delivered by the election will boost activity as households and businesses can take investment decisions with greater certainty over tax and regulation. Looking further out, the projected election results give the Conservatives the mandate to continue to implement its austerity plan, even if that plan has been eased in recent years. Government spending cuts are likely to continue, particularly in welfare payments where the government had sought to increase the relative gains for a return to work versus living on welfare.

With Cameron promising more money for the National Health Service and vowing not to increase taxes until the end of the decade, it makes it even more important for the government to find those efficiency savings and clamp down on tax evasion if fiscal targets are to be met. The fiscal deficit remains high at just over 5% of GDP, while the current account deficit is also close to record highs – highlighting a lack of domestic savings relative to domestic investment growth.

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