As the general election approaches and the media debates subside it’s time for the nation to decide. It’s not our place to make political comment but it is timely to share the perspectives of our independent economist John Calverley of Tricio, as well as from the Square Mile Investment team, both of whom feed their considerable resources and insights into our investment committee on a regular basis.
Economy – John Calverley, Chief Economist, Tricio.
The economy is picking up
The economy was essentially flat in 2022 and 2023 due to the energy price shock caused by the Ukraine war together with the effects of higher interest rates on mortgage payments. But activity has been picking up this year and official forecasts suggest GDP growth will be around 1% in 2024 rising to 1.5-2% next year and in 2026. This could be too cautious if the world environment remains benign.
Meanwhile, inflation has been decelerating rapidly, with core inflation (excluding food and energy) down to 3.5% in May from a high of 7.1% a year ago. This is still above the Bank of England’s 2% target but further deceleration looks likely, providing that wage growth, too, continues to ease back as expected. The Bank of England is likely to gradually cut interest rates, starting over the summer, supporting the economic upswing.
The incoming government will face two broad economic challenges. First, how to boost productivity growth. Secondly, how to meet rising demands for public services without (as promised) raising income tax, national insurance and VAT. They are interlinked because faster growth will help with the public finances but boosting growth may require more government spending in some areas.
Weak productivity growth
Future economic growth is unlikely to exceed 1.5-2% pa, (with much of that due to population increase), unless productivity growth picks up from the 0.5% pa seen recently. Productivity growth has slowed everywhere but the UK has been particularly badly affected. Brexit is likely one factor as the uncertainty after the vote pushed down business investment. Fortunately, investment has been picking up recently, likely helped by the new 100% first year capital allowance. Other factors holding down productivity growth are thought to be inadequate infrastructure investment, excessive regulation, a sclerotic planning system, poor business management and reduced trade competition (due to Brexit).
Moving the dial on productivity is hard. More infrastructure investment could help and the government may separate investment spending from current spending, to make borrowing to invest easier. But it will also be important how the money is spent. A radical reform of the planning process to speed up the process for commercial and residential permissions could bring big dividends over time.
Pressure on public finances points to tax increases
The pressure on public finances will be considerable. The outgoing government’s plans for spending beyond the current fiscal year (to next March), would leave many government departments facing big real-terms cuts which is likely unrealistic. Moreover, public sector pay has been squeezed under the Conservatives (after rising during the Blair/Brown governments) and will likely have to increase. Meanwhile, the NHS will require substantial extra spending to meet the demand for GP appointments and to reduce the backlog of operations.
The short-lived Truss government showed what happens if governments fail to fund spending and tax cuts properly, so the new government is likely to be cautious about borrowing. The Labour Party has proposed tax increases (on non-doms, private school fees etc) adding up to about £8.6bn. Further tax increases can probably be expected over time. In the end it is always people who pay taxes not companies or banks, so the key question will be their effect on incentives to work and invest.
Markets – Square Mile Investments
The UK election
Scandals like Partygate under Boris Johnson, policy errors causing market disruptions under Liz Truss, and general malaise under Rishi Sunak have led voters to seek new leadership. As a result, polls have long predicted a significant advantage for Labour. It was therefore a shock to many – outside of Westminster gambling circles, that is – that a general election was called early by the incumbent Prime Minister. However, the bold move to potentially catch the opposition off-guard seems to have backfired spectacularly.
Markets have not responded significantly since the election was called, nor to developments during the campaign, likely because many investors consider the result a foregone conclusion. The lack of response may also indicate that markets are not concerned about the outcome, particularly as Labour now presents itself as more moderate compared to its stance in the last election under Jeremy Corbyn’s tenure. This shift, combined with a necessary but yet-to-be-determined investment strategy, is likely reassuring for investors who above all else value stability and moderation in government. Moreover, historically, markets tend to shrug off election results. Looking back over arbitrarily long time periods, whilst wobbles are observable in and around election day, the general trend is almost totally unaffected by electoral developments.
The US election
The US election, scheduled for early November of this year, is not quite so predictable, and is a far cry from the comparative moderation of British politics. The rancour surrounding the presidency of Donald Trump has reignited as the former President has pulled a small lead on his rival, the incumbent Joe Biden, in opinion polls. This is despite Mr Trump having suffered a significant blow in being convicted on more than thirty criminal charges for using campaign donations to fund hush payments. The indignity of this is not lost on the American voting public, however, given the bombastic and fiery nature of the man was well-known to them already, this development has not ended up as the knock-out blow his opponents would have hoped for. In short, there are very few people left in the US or around the world that could still be surprised by the actions or words of Donald Trump.
The Democratic party of Joe Biden has had a torrid time of late. Perhaps unfairly blamed for issues pertaining to inflation, interest rates and geopolitical crises, they have also been stung by a series of gaffes relating to the aging President’s cognition as well as allegations of corruption relating to his son and to insider trading. It is for these reasons that Mr Trump appears to be holding a sustained lead over Mr Biden, despite the staggering possibility that the former may conduct at least part of his campaign whilst incarcerated.
However, the same point around the negligible impact of elections in the UK is true of the US. US elections have coincidentally fallen in tough periods for markets, for example 2001 and 2008, however, the general trend has been all but unaffected. Indeed, following Donald Trump’s shock victory in 2016, markets dropped sharply and almost as sharply, rebounded.
Governments have the capacity to shape policies that can materially alter business decisions, impacting how corporations and organisations function. Investors may, therefore, try to anticipate election results, to get ahead of the curve. But is that the best approach, given how long it typically takes for policy changes to be implemented?
Likewise, at FPC we don’t make a habit of forecasting short-term changes in policy, focusing instead upon sensible long-term financial planning to allow clients to face the future with confidence.
The improvement in the economic outlook could provide increased flexibility around borrowing to fund higher spending, without breaking commitments to lower structural debt in relation to GDP. Clearly, the potential is there for a rise in capital gains tax, which has been talked about for years now, and is an area that may wish to be revisited, though we think it unlikely there will be immediate changes undertaken during the current fiscal year.
Please get in touch with your adviser with any questions.
Mike Lea
Head of Investment and Senior Adviser
