the complete uk election preview

8/9/2019 The Complete UK Election Preview

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The Complete UK Election Preview

By Tyler Durden Created 05/06/2015 - 21:30

The UK General Election will be held tomorrow. The polls close at 10 pm.We should have a pretty clear picture of the overall seat count by 5 to 6 am onFriday morning. The result, as SocGen notes, is almost certain to be a hungparliament.

Then the fun will really start.

The leader of the incumbent Cons ervative/ Lib eral Democ rat coal i t ion

(David Cameron) stays in pow er unt i l or unless i t b ecomes clear that hedoes no t have the abi l ity to form a new g overnment. Most polls areshowing that the Conservatives will win the most seats but fall far short of anabsolute majority. That will then lead to a contest between them and theLabour party to negotiate with the other parties to form some type of formal orinformal coalition. The f i rs t test of th e new gov ernment wi l l be the vote onits legislative programme which is then presented in the Queen’s speech( tentat ively s cheduled fo r 27 May). That vote should be in the early part ofJune.

The main concern for the markets shou ld be whether or not a

Conservat ive- led coal i t ion is form ed that is suf f ic ient ly sup port ive of the

Conservative’s plans to allow them to hold the promised Brexitreferendum by th e end of 2017 .

Here are the possible outcomes (along with SocGen's probabilities)...


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[16]

As a reference, here are 2010's results:

http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2015/05/20150506_UK1.jpg


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[17]

And here are the key features of tomorrow's election relative to that

result...

1) A reduction in Conservative seats and an increase in Labour seats;



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2) A major fall in support for the Liberal Democrats who could easily see thenumber of seats won fall to less than 30;

3) A surge in the SNP seats from 6 to maybe even more than 50;

4) The poor performance of the UKIP (UK Independence Party), despite itsheavy influence on Conservative party policy in recent years. As the chartabove shows, they won NO seats in 2010. They currently have two seats as aresult of defections from the Conservative party but they will be lucky to wineven one more seat than that. So, in the absence of the most unlikelyoutcome of the Conservatives being only one or two seats short of a stable

government, UKIP would have no role in the formation of the nextgovernment.

The opinion polls show Conservative and Labour to be neck and neck

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SocGen concludes, there is a real choice between the broad fiscal plansof the Conservative and Labour parties.



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Labour w ould c ut the def ic i t more slowly to al low a higher level of net

investment than the Conservat ives p lan. That is a defensible position,worthy of debate at a time when financing costs are at record lows.

However, the key point for the markets is that both major parties have plansto c ont inue auster i ty at a pace that wou ld sat is fy the markets . Certainly,the Labour party has been accused of being anti-big business but that issomething that, if true, would only have a gradual impact on the economicfuture of the UK.

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More immediate ly w orry ing for the f inancial markets would b e i f the

Conservat ives w ere able to cons truct a form of co al it ion that al lowed



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them to del iver the promised B rexi t referendum by th e end of 2017. Thatwould create lasting uncertainty that could damage business and investorconfidence.

Deutsche Bank believes UK politics alone are unlikely to derail the

recovery or meaningfully change foreign appetite for UK assets, in theshort term at least and lays out 7 predictions for post-election UK...

Rather than try to guess the outcome, however, in this note we make a fewbroad brush predictions about what the post-election UK will look like forinvestors. Our conclusion is that while the politics is extremely uncertain, the

policy mix may undergo less rather than more change. Poli t ics alon e areunl ikely to d erai l the recovery or m eaningful ly change foreign appet i te

for UK assets, in the short term at least.

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For GBP, once the initial uncertainty over government formation has passed,the focus should quickly turn back to the monetary policy outlook. On thatfront, we still see the risks lying in earlier rate cuts from the Bank of Englandthan the market expects. For this reason we see value in using electionuncertainty as an opportunity to position into EUR/GBP shorts.

Predict ion #1: Fiscal pol ic y w il l be easier, but the defici t wil l fal l At the Budget in March, forecast tightening over the next five years fell from5.5% GDP to 4.4% as the coalition abandoned its goal of a GBP 23bn surplusby 2019-20, but the next two years were still projected to be roughly asaustere as at the start of the coalition.1 After the election, there is reason tothink this may change.

In the first place, Labour policy is less tight than implied by current forecasts. As the IFS notes, the party’s plans mean only moder ate reductions indepartmental spending may be required. Under the increasingly likely

probability the SNP holds influence over the next parliament, policy could beeasier still. The party currently advocates rises of 0.5% public spending in realterms. Note that even under SNP plans, Treasury analysis suggests that thedeficit would continue to fall.3 If the Conservatives were to remain in office,current forecasts may not materialize. The party eased off austerity in the

middle of the last parliament as growth suffered, and there are question marksover where additional cuts implied by their deficit plans will come from. The

party may also be helped by the improving growth outlook. Receipts havestarted to improve in recent months, and the OBR’s current gr owth projectionsare on the pessimistic side of official forecasters. In sum, and as oureconomist has noted, it may be helpful to look through the very noisy politicaldebate on the deficit, and focus instead on the underlying improvement in the

public finances. This has important implications for sterling, because the Bankof England’s inflation and growth projections as of the February InflationReport are currently predicated on the very austere fiscal path outlined in theDecember Autumn Statement. Easier fiscal policy should provide the bankwith more scope for monetary tightening.

Predict ion #2: There wi l l be no f iscal cr is is , whatever the ou tcome Even if fiscal policy were loosened, there seems little chance of a fiscal crisis.


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In the first place, the structural deficit has halved over the last five years.Perhaps more importantly, the markets’ understanding of fiscal risks hasmoved on since 2010, when a genuine loss of investor confidence in the UKfinances was arguably on the cards. As the Eurozone crisis has shown, debtand deficits are much more relevant when countries lack an independent

monetary policy. A lack of market concern is reflected in credit spreads, whichremain at pre-crisis lows. Third, the external environment is very favorable forUK assets. The ECB’s QE program had driven yields of core fixed incomenegative across the curve. One of the obvious beneficiaries should be the UK.The spread between 10-year UK and German yields is currently the widest onrecord. Today’s Bank of England data showed massive (GBP 26bn) foreignbuying of gilts in March, more than reversing outflows in the first two monthsof the year.

Predict ion #3: The UK w i l l remain o ne of the m ost at t ract ive dest inat ions

for foreign investment The last few years have been very positive for foreign investment. FDI inflowsto the UK have totaled over 8% of GDP since the fourth quarter of 2012,financing around half of the current account deficit. The policy mix has playedan important role. The corporation tax rate has fallen from 28% to 21% overthe last five years, seeing the UK leapfrog above every OECD country saveSwitzerland in terms of corporate tax competitiveness. On the margin, aLabour-led administration would imply a moderately less positive investmentclimate than a Conservative one, but the policy mix is not set for wholesalechange. The party favors keeping the corporation tax rate at its current lowlevel (against another 1% cut proposed by the Conservatives). We doubt thatother Labour party policies such as a mansion tax, changes to the non-domicile status of taxpayers and rises in the top rate of income tax, will resultin a foreign exodus. Significant changes to the tax treatment of non-doms andforeign purchases of UK property were made by the current coalitiongovernment over the last five years with no apparent effect on foreigninvestors’ appetite for UK assets.

Prediction #4: A new Scottish referendum won’t happen anytime soon Last year’s Scottish independence referendum generated panic amonginvestors as it became apparent that a ‘yes’ vote was a real possibility, with

potentially destabilizing consequences for the UK banking system andeconomy. But even if the SNP were to hold the balance of power after the


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next election, it seems unlikely that a new referendum would materialize soon.The party made no mention of another referendum in its manifesto releasedearlier this month. This should not be surprising – recent polling suggests thatthe issue ranks extremely low on Scottish voters’ priorities. Even if the SNPwished to reintroduce the question over the next five years, the party’s

leverage over a future Labour government may be overestimated (seePrediction #6). A more likely date for the issue to be reintroduced is after theScottish parliamentary elections in May next year, assuming the SNP holds onto its majority in the Scottish parliament. But it is also worth pointing out that afuture referendum would likely be less destabilizing than last year’s events.Precisely because of uncertainty in September, authorities and businessesare now much better informed about the risks of a Scottish exit, particularlywith respect to risks concerning the banking sector.

Predict ion #5: An EU referendum m ay be good fo r the UK economy Under the Conservatives, a referendum on the UK’s membership in theEuropean Union would likely be held before 2017 following a renegotiation ofthe UK’s terms of membership. A ‘Brexit’ could have severe c onsequences forUK growth performance and foreign investment, and the potential impact onbusiness confidence leading into a referendum has been widely noted.6 Lesscommented on, however, are the potential benefits that a renegotiation couldbring to the British economy. As our economists have argued, the UK isuniquely placed to benefit from reforms to the EU Single Market and theDepartment for Business Innovation and Skills has estimated that the potentialgains for British exports could add up to 7% GDP.7 A referendum may be anideal bargaining chip for the UK to remodel aspects of the EU in its favor. Ofcourse, this would depend on an ‘in’ vote, but polls currently suggest amajority in favor of staying in, particularly after a successful renegotiation.

Predict ion #6: A Labou r mino r i ty government would be mo re stable than

you m ight th ink If no party wins a majority next Thursday, the UK faces the prospect of acoalition or minority government. In the event that SNP support is required to

pass legislation in the House of Commons, an increasingly probable outcomegiven the latest opinion polls in Scotland, the latter seems the more likelyoption. Labour has ruled out a formal deal with the nationalists. Some haveargued that if the SNP held the balance of power, the result could bedestabilizing, but the party’s leverage may be less than thought. Even if the


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SNP found Labour un coop erat ive on key pol icy issues, i t would no t be

rat ional for them to br ing down the government with a vote of no-

conf idence.

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This would cause a new election, a possible future Conservative government,and damaging Labour accusations that the SNP had voted down a

‘progressive’ administration (we outline the SNP’s options on a decision tr eeon the previous page). The party also looks set to perform exceptionally wellnext week, with some polls suggesting a near clean sweep of Labour’s seats.It is unclear why the party would want to risk these with a new election.



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Predict ion #7: There may b e less change rather than more Precisely because no party is likely to have enough seats for a majority, it isdifficult to envisage sweeping changes to the policy mix. The last five yearshave seen the deficit cut in half, the employment rate reach a record high andUK growth accelerate above any other advanced economy. Major challenges

remain, however. The current account deficit has reached a record, meaningmuch-vaunted ‘rebalancing’ has failed to occur. Productivity has also been theweakest among any G10 country. This has important implications for wagegrowth, which has been very slow relative to previous recoveries. Indeed, thecurrent fracturing of the UK’s political environment can indirectly be attributedto imbalances in the labour market. Pollsters find that a key explanatoryvariable behind support for the UK Independence Party (UKIP), for example,is lack of a university degree. 8 It is unclear whether any major party has thesolutions for these issues, but also doubtful that it will have the electoralresources. On the other hand, the doom-laden predictions of certaincommentators are unlikely to materialize.

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Finally, Goldman simplifies the decision process to three potentialoutcomes. While there is a whole range of potential outcomes to the May 7election, each of the most likely governmental combinations falls into one ofthree broad groupings:

1. A Conservat ive-led g overnment (either on i ts ow n or in co al it ion w ith

the LibDems). This is likely to be perceived as the most ‘market -friendly’outcome, partly because it would come closest to maintaining the status quoand also because the Conservatives’ stated aim is to reduce the budget deficitthrough cutting current expenditure rather than by raising taxes. Set againstthis, the Conservatives’ commitment to hold a referendum on EU membershipby 2017 and the increased risk of exit would likely be negative for investmentspending and UK assets.

2. A L abour- led government (either on i ts own, with the impl ic i t sup port

of the SNP, or in a form al coal it ion w ith the LibDems) would shift thebalance of further fiscal adjustment away from spending cuts to tax increases.Labour’s proposals include: raising the top rate of income tax from 45% to50%; raising the headline corporation tax rate from 20% to 21% (offset bymeasures designed to help small businesses); increasing the ‘Bank Levy’ onbanks’ balance sheets, applying a second ‘one-off’ tax on bank bonuses,


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removing the non-domicile tax st atus and introducing a ‘Mansion Tax’ onresidential properties worth more than £2 million. At the same time, agovernment of this complexion would be less likely to contemplate areferendum on Britain’s EU membership.

Of the potential Labour-led government combinations, financial markets wouldlikely respond more favourably to a Labour/LibDem coalition than to a minorityLabour government supported by the SNP on a confidence and supply basis.(The Labour party has ruled out a formal coalition with the SNP.) In thisscenario, concerns are likely to emerge that reliance on the SNP would pullthe Labour government away from the centre to the left of the politicalspectrum, as well as raising the spectre of distributional policies favouringScotland at the expense of the UK as a whole.

3. It is also po ssib le that there wil l be no clear outc om e to the elect ion. Ifno party (or coalition of parties) is able to form a stable government, a secondelection could be called shortly after the first or a minority government mightattempt to struggle on. Again, the lack of clarity surrounding such an impassewould likely be damaging for UK growth and assets.

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The Bottom Line is that at the macro level the implications of theelection may be less pronounced than many anticipate. Monetary policyhas been de-politicised through the Bank of England’s independence.Moreover, the formation of a coalition government is likely to involveconvergence towards centrist positions, while a minority administration thatpursues policies outside the mainstream would be unlikely to survive given itsfragile parliamentary basis. In either case, the political system is unlikelyto deliver radically different macroeconomic outcomes.

Sources: Bloomberg, Goldman Sachs, Societe Generale, and Deutsche Bank

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