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Befitting their stable lead in the polls, the Labour party secured a landslide majority in yesterday’s General Election, winning 410 seats in the House of Commons, with just six constituencies left to declare.
This gives Keir Starmer’s party a majority of 170 seats as of writing, just a handful short of the post-war record of 179 set by Tony Blair in 1997. The Conservatives meanwhile slumped to a crushing defeat, losing 249 MPs. Even so, there will likely be some relief at Conservative HQ, with the 119 seats won landing towards the upper end of pre-election estimates, which had warned that yesterday’s vote could turn into an extinction level event for the Tory party. For markets too, the eventual outturn was towards the more friendly end of potential scenarios; a commanding Labour majority provides political stability, while the Conservative’s winning more than 100 seats ensures an effective opposition. This saw sterling trade unnerved overnight and into the European session as the results trickled in, befitting with the supressed level of volatility priced into GBP options.
Markets will now be looking to see more details around Labour’s fiscal plans, before passing further judgement on the new government.
In terms of what can be expected from the incoming administration, there are a few points that we can distil from last night’s results. First, the turnout around 60%, expected to be the second lowest since 1885. Second, Labour secured just 35% of the vote, only 2% up on 2019, but below the levels of support garnered by Jermey Corbyn in 2017. The Conservatives meanwhile exceeded their expected vote share, gaining 24%, though this was down 21% on their 2019 performance, while Reform and the Lib Dems scored 15% and 12% of the vote share respectively.
This lack of enthusiasm for Labour, combined with the survival of enough of Tory MPs to form an effective opposition in the Commons, suggests to us that the incoming government will have only minimal room to move left once in power.
That is perhaps fortunate given that Labour will inherit a challenging fiscal position. The outgoing Chancellor Jeremy Hunt left almost no headroom against his fiscal rules, which Labour have promised to emulate. Indeed, we doubt that Labour would attempt the alternative approach of Liz Truss, having seen the damaging impact of junking the fiscal rules and announcing unfunded tax cuts back in 2022. This implies either significant cuts to public services, or substantial tax rises, are on the way. Current spending plans assume that government spending outside health, education and defence will fall 1.9-3.5% annually in real terms over the next five years. While firm spending commitments are yet to be announced, Labour’s manifesto policies imply government expenditure will increase £9.5bn relative to current plans, funded in large part by an increase in taxes.
If the pre-election policies are delivered, this should have little impact on the UK’s fiscal trajectory or growth outlook, though we are modestly upgrading our growth forecast for the UK in anticipation of modest reforms to areas such as planning, which should help boost the economy at the margin.
That said, we await further detail before making more concrete predictions, with this only likely to come at a budget in October or November, though the Labour Party Conference in late September could offer some early hints. Either way, the prospect for modestly stronger growth supports our call for sterling upside over the longer term.
After the dust from the election settles, however, there is still much for markets to digest.
In fact, as we noted in our July outlook, we felt the biggest short-term risk for sterling was the resumption of BoE commentary, once the communications black-out is lifted. In this sense, we think the comments from Governor Bailey are particularly significant, having stated in early May that: “It’s likely that we will need to cut bank rates over the coming quarters and make monetary policy somewhat less restrictive over the forecast period, possibly more so than currently priced into market rates.” At that point markets had 2.5 cuts to Bank Rate priced for 2024 – swaps now project just 1.7. Placed in the context of the June meeting minutes, which suggested that policymakers are desperate to cut rates, markets could be in for a dovish shock next week, which we think could weigh on sterling in the short run.
Author:
Nick Rees, FX Market Analyst