A secure majority government should reduce political instability for the nation, helping companies and investors to anticipate policy changes says Azad Zangana, Senior European Economist & Strategist at Schroders.
The UK is going through its biggest political change since Brexit, as the early general election results suggest that the Labour Party have won a landslide mandate to govern.
The at least 168-seat majority put it ahead of the 2001 victory by Tony Blair’s government. Moreover, the change in votes and seats compared to the 2019 election means that this is one of the largest political swings in the UK’s history.
The election results show that the surge in support for the right-wing Reform UK party severely hurt the outgoing Conservative government, where Reform frequently beat the Conservatives into second place in a number of constituencies. Often, where the votes of the two parties are combined, they would have beaten Labour to those seats. However, the results show that the Conservatives have lost over two-thirds of their seats, leading to major questions over the future of the party.
Keir Starmer will become the first Labour Prime Minister since May 2010, and will have to quickly get to work to form his government, before heading off to an important NATO summit next week.
Investors and businesses benefit from political stability
In terms of policy changes, the election campaign revealed very little new information about the Labour government’s plans. Its stated priority is to grow the economy and provide security and stability, the importance of which should not be overlooked from the perspective of investors. The last parliament has been dogged by political instability and uncertainty. Since the December 2019 election, there have been three prime ministers and five chancellors. A recent study by Strong and Stable found that the average cabinet minister’s tenure fell to just eight months – the lowest average over the 1974-2023 period. Although governed by the same Conservative Party, this level of instability makes it very difficult for companies and investors to anticipate policy changes and work with government.
Having had a largely stagnant economy since outgoing Prime Minister Rishi Sunak took office, the focus on boosting growth to enable greater spending on public services is a logical approach to the Labour Party’s objective.
In the near-term, the economy is set to rebound following a recession at the end of last year, but structural challenges remain including an aging population and strained trade relationships. Reforming the planning system and making the UK a more attractive destination for foreign direct investment should be top of the government’s priorities.
The likely new chancellor Rachel Reeves plans to exclude public investment from the government’s self-imposed borrowing rules. This is a signal that Labour plans to borrow more to invest. The lines between public current spending and investment have in the past been blurred, which may in time raise some concerns.
Tough legacy to inherit given heavy existing tax burden
Moreover, there is a general expectation that some taxes will have to rise in due course, despite Labour’s manifesto pledge to freeze most personal taxes. This will be difficult given the “fiscal drag” which is occurring as the result of frozen income tax thresholds for the past seven years.
With more and more workers paying higher marginal rates, the nation’s tax burden is expected to rise to its highest level since 1948 by the end of the Office for Budget Responsiblity’s current forecast period – a tough legacy to inherit.
Overall, the change in government, particularly with such a large majority, should reduce political instability for the nation. A change in the direction of policy back to growing public services is likely to lead to looser fiscal policy and boost economic growth.
However, the significant support for Reform UK is likely to put pressure on Labour to restrict inward migration. This would limit the economy’s growth prospects as its aging population is already impacting staff availability, pushing wage inflation higher.
Given the result was largely as expected, there has been little to no reaction from markets. Members of the Monetary Policy Committee at the Bank of England have not been allowed to give speeches in recent weeks owing to election purdah rules. They are, however, expected to return to public speaking soon, and again start to signal imminent cuts to interest rates, potentially from August onwards.
