The Economic and Market Impact of a Change in Government
This article is by Justin Rourke – Head of Advice at Armstrong Watson Financial Planning & Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. We aim to provide you with our commentary on the latest economic and investment developments which are likely to be affecting your investment and pension portfolios.
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In this latest market update we discuss what the new Labour Government means for investment markets and the impact Rachel Reeves, The Chancellor, will have moving forward.
2024 has been discussed as the busiest year for global democracy, with dozens of countries heading to the polls, representing around half of the world’s population. While the US presidential election in November carries significant global implications, the UK general election has generated the most domestic interest. Given the Conservative party’s trailing position in the opinion polls, Rishi Sunak had been expected to delay the election until autumn, aiming to enhance the public’s perception of his government. However, following improvements in inflation data, the return to growth of the economy following the brief recession of late 2023, and a likely desire to catch his opponents underprepared, the now former prime minister opted for a summer election.
What followed was a lacklustre campaign from the Conservatives, who suffered from both a Nigel Farage-inspired Reform to their right and a well-organised campaign from Labour to their left. As a result, Sir Keir Starmer is now prime minister, with Rachel Reeves, an ex-Bank of England employee, serving as chancellor.
So, what does this mean for investment markets? In the short term, the market response to this was limited, with both UK equities and gilts neutral to slightly positive in the week following the election. With a large Labour majority having been widely expected, this result had been ‘priced in’ by investors in the run-up to the vote, explaining the lack of big reaction.
Where markets go from here, however, will depend in part on the success Chancellor Rachel Reeves has in shaping the economy to her liking but also on wider factors, over which she has limited influence.
Outside the Chancellor’s control
The paths of inflation and interest rates stand out as critical factors affecting market sentiment and remain largely independent of the new government. UK CPI declined to 2% in May and remained there is June, aligning with the Bank of England’s inflation target for the first time since July 2021. This raised hopes of an interest rate cut in the coming months, particularly as inflation is also falling in Europe and the US. However, as our experience over the past year has shown, interest rate expectations can shift rapidly. Inflation is forecast to rise again in the second half of 2024, with high wage growth a major contributor to persistently high inflation in the services sector.
Furthermore, the UK economy has outpaced expectations this year, with Q1 data exceeding projections. Q2 also appears to be improving, with May’s growth twice the expected rate, at 0.4%. Enhanced economic growth is undoubtedly a positive development, evident in the recent strength of the British pound. Meanwhile, individuals receiving pay raises above the inflation rate are unlikely to voice complaints. However, if these signs of strength lead the Bank of England to delay interest rate cuts, it could dampen the anticipated stimulatory effect on domestic equity and bond markets compared to what might have otherwise occurred.
Political stability
Turning attention to the potential impact of the new government on markets, there are a few points to consider. The prime minister has a large parliamentary majority and has appointed a fiscally orthodox chancellor who, while in opposition, regularly consulted business leaders when shaping policy and it seems will likely continue to do so now she is in office. As such, it appears that the new government has the potential to deliver a period of political stability and believes a successful business environment is key to delivering higher economic growth.
The UK has faced challenges in maintaining political stability in recent years and this has impacted the UK’s desirability as an investment destination. If the new government can foster a business-friendly environment for both domestic and international companies, then the UK economy as well as markets should face improved prospects.
Policy impact
We will need to wait until a full Budget in the autumn to get a clear picture of the outlook for taxes and spending, but that doesn’t stop the chancellor from making other announcements before then. In the days after the election she delivered a major speech on planning reform, with the aim to increase house building, while she has also announced the launch of a £7.3bn National Wealth Fund focused on stimulating the green economy, unlocking much higher levels of private investment in the sectors. The launch of GB Energy will also be a way for the government to support a target industry.
These projects’ full impact will unfold over several years and they are therefore unlikely to have a significant effect on economic figures in the short term. Nonetheless, it is positive that the government appears to prioritise productivity improvement. The chancellor may yet lose favour with investment markets, particularly if unfunded spending commitments or suffocating tax rises are enacted in the coming months. Yet, so far, markets view Rachel Reeves and her declaration that higher growth is a “national mission” favourably.
An improving economy
Against this background, investors will anxiously await the Budget for further details on the government’s fiscal policy, yet they have taken comfort from Rachel Reeves’ early indications of support for the business community. This will be far from a cure for all the challenges faced by markets, but with lower inflation, improving economic growth and the potential for greater political stability, the UK economy is in an improving environment.
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Important Information
Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.
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