General election - What markets and businesses now expect from Labour

Market reaction was rather muted, as most of this was in the price. At the time of writing, UK large cap futures were up 1% versus Wednesday’s close, and the yield for the UK 10-year Gild was very near the average levels of the previous days.

For markets, the question was never “who will win the election”, as this was by and large a foregone conclusion. Rather the issue was the one that was purposefully never discussed during the election period: relations with the EU. Following 2020, economic performance has been lacklustre, inflation more persistent and the London Stock Exchange has not been at the top of business preference for listing. Whether right or wrong, investors have linked below-trend economic performance to Brexit.

Money managers generally prefer two types of assets: high-growth assets, which can typically be found in US markets or some selected companies in Europe, and deep value ones, usually in emerging markets. All other in-between assets are of course investable, but they need a clear catalyst which would generate more profits.

For UK risk assets, markets perceive that a positive catalyst for a revaluation is repairing the fractured relationship between the country and its largest trading partner, the EU. Markets have quietly been assuming that a Labour victory will see the UK mending the fences with its neighbours. A basic post-Brexit deal in the trading of goods may have been implemented, with plenty of room for improvement, but the legal framework for the trading of services, and especially financial services, is still fluid.

For markets, thus, the catalyst for a reaction will probably come in the next few days. A Labour government seeking a closer relationship with the EU would possibly translate into improved economic performance and be well-received by markets. It’s the opposite, ignoring the matter altogether, could come as a disappointment for investors.

The other key issue is growth. To maintain its lead, the Labour Party chose a generally positive message of “hope” on economic growth. Hope isn’t a strategy, is often said. It may have won votes, but now it needs to be translated into a structured plan for governing.  With a deficit of 4.5% and Debt / GDP at 108%, fiscal space is very limited. UK governments have learned to be careful with the budget, after Liz Truss’s debacle in 2022. Yet Labour leaders have suggested that they will not be aggressive on taxation either. So, free from the constraints of campaigning, investors are now keen to figure out where growth will come from.

The election wasn’t the catalyst for market reaction. It is what comes right after that will probably affect UK risk assets.

George Lagarias, Chief Economist