CONTRIBUTORS
Matti Karp
Junior Research Analyst Brandywine Global
On July 4, while Americans were busy firing up the BBQ to celebrate their independence from Great Britain, those in the UK were in the voting booths, deciding on which party to lead the country.
Results
Having been polled to achieve a strong majority, the Labour Party, led by newly elected Prime Minister Sir Keir Starmer, performed as expected, acquiring 412 seats with a 174-seat majority. This outcome was coupled with the worst performance by a Conservative party in history, losing 251 seats to reach a total of 121.
However, despite Labour undoubtedly doing well, the vote share among the parties painted a slightly different picture (see Exhibit 1). Despite gaining over 200 seats, Labour only received approximately 23,000 votes per seat and increased their vote share by only 2 percentage points since the last election. While the first-past-the-post electoral system may have worked for them, it certainly went against Nigel Farage’s Reform UK, which only won 5 seats despite receiving approximately 4 million votes and sizable share of the vote. These results may influence Labour to consider Reform UK’s perspective on issues like immigration, an area of policy on which Farage’s party particularly focused. However, due to its large majority, Labour is expected to push through its agenda widely uninhibited.
Exhibit 1: 2024 UK General Election Vote Share
Percent. As of July 8, 2024
Sources: Brandywine Global, Macrobond, UK Electoral Commission.
The Economy and growth
Learning from Former Prime Minister Liz Truss and the liability-driven investment (LDI) funds crisis and gilt market turmoil of 2022, Starmer has said numerous times that such mistakes will not be repeated. As such, Labour’s manifesto is largely fiscally neutral with total net policy measures amounting to approximately £0.5bn GBP, and higher spending offset by increased taxation.
Starmer, keen to prove his party’s departure from former leader Jeremy Corbyn’s “radical” agenda, has proposed several modest policies. Some of the key policies outlined in the manifesto include the clean energy Green Prosperity plan with a cost of around £5bn per year over the next 5 years as well as increasing health care spending, reducing tax avoidance, expanding teacher training, and adding 3,000 more nurseries and 13,000 more police officers. Addressing the housing crisis also remains a priority. Starmer has pledged to build 1.5 million homes during his term and also support younger people in new housing developments with a government-backed mortgage guarantee scheme. Labour plans to finance these through closing controversial non-domiciled, or “non-dom,” tax loopholes, tackling tax avoidance, implementing a value-added tax (VAT) on private schools, reducing carried interest, and imposing a windfall tax on oil and gas companies. However, while Labour claims these measures will be enough, the Office for Budget Responsibility (OBR) will ultimately determine the projected tax revenue of these policies.
Starmer has highlighted his party’s push toward higher growth and pledged to lead the UK to the highest sustained growth in the G7, but his policies are forecasted to add only approximately 0.15% to gross domestic product (GDP) by 2030. However, the modest policies suggested so far may be a bid to avoid any immediate adverse reaction from the markets, with more ambitious plans to come later in the party’s tenure. Emboldened by his party’s large majority, increased spending in green investment, defense, planning, and trade could all be implemented with the potential to further enhance GDP.
Since Brexit, capital expenditures (capex) have significantly deviated from their historical growth trend (see Exhibit 2). However, with a government committed to growth and priorities that include increased integration within the European Union (EU), this shortfall is expected to correct itself.
Exhibit 2: UK Capex from Trend
GBP, billion. As of January 31, 2024
Sources: Brandywine Global, Macrobond, ONS.
Implications for markets
- Policy Rates: With Starmer’s likely cautious approach at the beginning of his tenure, policy rate expectations are unlikely to change significantly with moderate spending increases balanced by increased taxation, although some net fiscal easing is likely. The Bank of England’s Monetary Policy Committee (MPC) is unlikely to change its rate-cutting path. An August cut is expected, followed by an additional cut later this year and four further cuts in 2025, leaving rates at 3.75% at next year end. However, if the autumn budget leads to more net fiscal easing than expected, rates may ease more gradually.
- Gilt Yields: With the government's implementation of cautious spending policies, financial markets anticipate that bond yields will align closely with the interest rates established by the MPC. This alignment is likely since investors adjust their expectations based on the government's fiscal discipline, reflecting a stable outlook for government borrowing costs and overall economic policy.
UK-Euro 10-year spreads remain at elevated levels (see Exhibit 3). Furthermore, the geopolitical outlook for Europe looks increasingly unstable with potential gridlock in France and the emergence of the far-right within the EU. We expect gilts are likely to see improved flows from investors looking for safe-haven investments. Gilts may be further supported by foreign inflows, since approximately only 25% of UK debt is owned by foreign investors. A stable government with a clear majority and greater integration with its trading partners could persuade these investors to allocate more capital to UK assets.
Exhibit 3: UK 10-Year Yields vs. Euro 10-Year Yields*
Percent, As of July 8, 2024
* 50/50 French 10-year OAT and German 10-year bund yields
Source: Bloomberg (© 2022, Bloomberg Finance LP)
3. Pound sterling: On the currency front, a closer relationship with the EU expected under Labour could see the pound rally against the euro, reducing sterling’s “Brexit premium.” Although, it is important to note Labour has ruled out rejoining the customs union or single market. Data from the Department for Business and Trade showed that foreign direct investment (FDI) projects in the UK decreased 6% in 2023-2024 from 2022-2023 and declined 31% from the peak in 2016, when Brexit was initiated.1 Approximately 40% of UK FDI comes from the EU (see Exhibit 4). A strong majority with stronger ties to the EU should curtail any concerns and encourage further investment, leading to appreciation of the pound.
Exhibit 4: Top Source Markets for FDI Projects into the UK
Proportional. June 31, 2023 – June 31, 2024
Sources: Brandywine Global, Macrobond, UK Department for Business & Trade.
Conclusion
The Labour Party’s historic election win, which ended 14 years of Conservative power dynamics, was nothing short of massive. Next to Starmer’s landslide, only Tony Blair’s Labour Party captured more seats. However, political divisions, post-Brexit and post-pandemic weakness, and broader European uncertainty leave the UK in a precarious balance. While the party’s commanding majority may appear to give it unfettered influence, its actual impact may be more tethered, and life under this Labour Party may be more nuanced. However, this expected stability and greater integration with Europe should keep rate expectations on track, supporting yields and boosting gilts’ safe haven status. More measured spending programs may fall short of Starmer’s lofty pledges to invigorate growth, however, current proposals along with a possible uptick in foreign investment should help spur some appreciation in pound sterling.
Endnote:
- Source: UK Department for Business & Trade, “Inward Investment Results 2023 to 2024.” June 2024.
Definitions:
G7 refers to Canada, France, Germany, Italy, Japan, United Kingdom, and United States.
Capital expenditures (Capex), also called capital spending, is an amount spent by a company to acquire or upgrade productive assets (such as buildings, machinery and equipment, vehicles) in order to increase the capacity or efficiency of a company for more than one accounting period.
Gilts are bonds that are issued by the British government.
A liability-driven investment (LDI) is an investment in assets that can generate the cash to pay for financial obligations (liabilities). This type of investing is common with defined-benefit pension plans because companies and pension funds are obligated to provide the guaranteed income promised to the beneficiaries.
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