After calling a snap election, Rishi Sunak and the Conservative party lost the UK General Election last week, seeing Labour come into power for the first time in 14 years. So, with Keir Starmer now Prime Minister, what does that mean for the country and, as a consequence, UK investors? 
Our CIO Mark Harries explores the new government's likely impact and implications on the broader economy with Hugh Gimber, Global Market Strategist at J. P. Morgan Asset Management, and James Ashley, Head of Market Strategy at Goldman Sachs Asset Management.

Key points: 

• Macroeconomic and fiscal policies: The new Labour government is not expected to make radical macro-level policy changes but rather significant sector-specific changes. A detailed fiscal review in an Autumn statement may prompt further shifts.
• Economic growth: The outlook for UK economic growth is positive, with increasing consumer confidence and possible rate cuts from the Bank of England (BOE).
• UK inflation: Inflation remains a concern, with core inflation still high. The BOE may only gradually reduce rates to avoid reigniting inflationary pressures.

The impact of the new Labour Government

While the Labour Party campaigned for change, macro-level policy shifts are unlikely. However, significant sector-specific changes may occur, impacting households, such as introducing VAT on school fees and reforming non-dom rules. A detailed fiscal review is expected in an Autumn statement, possibly in November, which might prompt more significant changes.
The UK bond market's reaction in September 2022, when it rejected radical changes and aggressive spending by the Conservatives, still influences both parties' plans. Consequently, there were minimal economic differences between the two parties in the recent election. The existing momentum in the UK economy will, therefore, likely drive growth in the coming months rather than any major shift resulting from the election outcome.

The future for UK economic growth

The outlook for the UK economy is positive, with the UK consumer looking increasingly optimistic thanks to positive real wage growth for the first time in a number of years. That's leading to consumer confidence picking up, which can be seen in some retail sales data. Arguably, this is a sign of an accelerating economy, albeit from a pretty low base. 
Furthermore, now that the election result has been decided, any lingering uncertainty about when the government might change and the path of policy ahead has been removed. Businesses and consumers can now look ahead with more confidence. Plus, this comes at a time when potential BOE rate cuts could add to that positivity over the course of the autumn. 
When it comes to the amount of growth, though, caution remains critical. There is a disparity between the official forecasts from the BOE and the Office of Budget Responsibility (OBR) - with the BOE’s outlook more negative than the OBR. A period of higher for longer interest rates could be on the cards, with the potential for lower tax revenues. 

UK inflation

In the short term, UK inflation will be influenced by UK-specific factors such as energy costs. However, while the CPI is currently at 2%, core inflation remains high and may take time to decrease. While the BOE may cut rates in the second half of the year, it must consider the dynamics between core inflation and wage growth. Real income growth will be a concern even though households won't fully recover their lost purchasing power from recent years.

In the longer term, inflation could stabilise at about 3%, mainly due to fading energy effects and wider global influences. It’s also helpful to remember that, over the past few decades, inflation has primarily come from services, not goods. Now, though, goods inflation is expected to rise due to changing supply routes and climate change. Achieving a sustainable 2% inflation rate will be challenging, with 3% being more achievable. So, with inflation above 2%, the BOE will approach rate cuts as normalisation rather than easing. The BOE will likely reduce rates gradually to avoid reigniting inflationary pressures.

Public debt in UK 

Labour’s campaign has reassured UK bond investors, indicating the government’s awareness of constraints on unfunded spending, despite debt to GDP not falling soon. With a budget approaching, it will be interesting to see if the fiscal rules, currently requiring debt to GDP to fall over the forecast horizon, will be adjusted for more spending flexibility. The party’s plan for managing debt will undoubtedly be tested, when deviations from forecasts occur. However, the government's commitment to fiscal prudence and the lessons from the LDI crisis does mean there are no immediate concerns. 

That being said, high debt-to-GDP levels across developed economies limit the capacity to respond to future setbacks or recessions. As a result, fiscal rules may evolve, distinguishing between day-to-day spending and investment spending to address specific economic needs. Despite possible changes, the government is expected to move cautiously to avoid repeating past crises.

Finally, the UK is no longer seen as an outlier in government spending compared to countries like France and the US, where increased spending is expected. In that context, the UK has better visibility on its government bond yields compared to US treasuries, which face larger fiscal risks.
The impact of the new UK government on key industry sectors
Healthcare is the largest component of UK public spending, yet NHS treatment waiting lists have reached 7.5 million, the highest in its history. And, even if the waiting lists were to be under control, the UK must increase spending on health and social care due to an ageing population and higher health inflation compared to general inflation - raising questions about funding and timelines. For instance, only 5% of NHS spending goes towards infrastructure despite the significant backlog in critical infrastructure investments. Funding this backlog presents another major challenge for the new government.

Labour also needs to address low business investment and labour force participation, which lag behind the Eurozone and the US. Improving participation rates is crucial for reducing NHS waiting lists and preventing wage growth from becoming entrenched. Enticing private investment is key to solving the UK's infrastructure challenges. Opportunities for private investment, such as in infrastructure improvements, could boost productivity and bring long-term economic benefits.

On the subject of education, the incoming Labour Party's proposal to apply VAT to private school fees could lead to a migration of students from private to state schools, straining the state education sector before it can expand. The expansion will require investment from the government, though the change in policy may pay for the investment in the future. 

Global economic trends and the UK Economy 

US-China trade tensions remain uncertain, but it’s not unrealistic to anticipate a trade deal between the two nations next year. Monitoring events in real-time will be crucial, as escalating tensions benefit few.
Global growth, including in the UK, will generally be weaker, with inflationary pressures everywhere. However, the consumer outlook in the Eurozone is improving, similar to the UK's. Despite ongoing political turmoil - with the recent French election being a prime example - Europe’s recovery should aid the UK as, due to being a small open economy, the UK is influenced by global trends. For instance, while national factors will always matter, decarbonisation and climate change trends will significantly impact the UK.

A global shift towards increased defence spending looks likely to be the case for Labour too. The party has said it supports increasing defence spending to 2.5%, aligning with the outgoing Conservative government's stance, though without a specific commitment. The increase reflects a meaningful shift in the broader international defence landscape as global tensions and wars continue. 

2024 - The year of the election 

Political uncertainty, especially around major events like the US election in early November, introduces volatility, which can be seen as both a risk and a re-pricing opportunity for investments. Increased US-China tensions have led to significant investments in areas such as semiconductor capacity, with the US incentivising companies like TSMC to build within its borders. The result has been reduced capital flows to China, benefiting other countries like India. 

The US election is significant and could cause further market volatility, emphasising the need for portfolio diversification. Diversification should go beyond bonds and involve consideration of the types of risk too, especially as government spending becomes a vital issue. It’s important to remember opportunities exist alongside risks, necessitating a broader diversification strategy to manage potential election outcomes.

Long term challenges 

The UK faces significant demographic changes in the coming decades. Currently, about 40% of the population is aged 30 to 60 and is the primary contributor to the economy. About 15% of the population are over 70 and, conversely, withdraw from the economy. In 30 years’ time, the working population will decrease to 35%, and those over 70 will exceed 20%. The current and future governments must address this challenge by building robust workforces to sustain economic contributions and meet the rising demand for healthcare.

Globally, similar demographic shifts and the need for climate action will necessitate substantial policy changes. Investments in renewable energy are crucial, as seen in the US Inflation Reduction Act and the EU Repower Act, which provide direct investments and tax incentives for sustainable energy. The US CHIPS Act also exemplifies efforts to bolster future-focused technology sectors like semiconductors.

While these investments could increase short-term inflation, they are essential for long-term benefits. For example, investing in AI and semiconductor technology can enhance productivity in the future. Similarly, transitioning to renewable energy requires substantial infrastructure investments today to achieve lower production costs and environmental sustainability in the long run.

Tackling economic inequality 

The philosophy and ethos of the Labour Party suggests that they'll be focused on tackling economic inequality and supporting the vulnerable. Yet, their manifesto commitments do not appear to be radical in terms of specifically supporting this. 
However, when looking at the tax changes that Labour have ruled out, they've not yet said anything material about capital gains tax (CGT) or wealth taxes. CGT was notable in that it wasn’t referenced during Labour’s election campaign, so if Labour wanted to try to redistribute across the income spectrum, that would be the obvious way they do so. If they did make changes on these taxes, it could have significant implications for investors. 

Key stats

• UK business investment is 3% lower than in 2007, while the G7 (excluding the UK) is 39% higher, and the US is 73% higher. 
• The combined Labour and Conservative vote share was 57.4%, the lowest in over 100 years. 
• Buckingham Palace's council tax is £1,828 annually, less than the average three-bed semi in Blackpool.

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