Consider This: “It’s All Too Much”—UK snap elections

The Beatles’ George Harrison wrote “It’s All Too Much” after experimenting with the hallucinogenic drug LSD. The song was not a commercial success. But oddly enough, it captures the public mood in the United Kingdom after a torrid decade of Brexit, COVID-19, rising inflation, higher interest rates, and five prime ministers and seven chancellors in the last 14 years (with three prime ministers in the last four years).

After 14 years in government, political parties tend to struggle in democracies, as they usually run out of ideas or are beset by internal divisions and cannot disassociate themselves from their track record. The polls ahead of the 2024 UK election have been remarkably stable over the last two years, showing the opposition Labour Party ahead of the Conservative and Unionist Party by a margin of around 20 percentage points. Prime Minister Rishi Sunak called a snap election for 4 July, catching most by surprise—and likely complicating the US ambassador’s plans for US Independence Day holiday celebrations that day!

This election campaign is mercifully short (six weeks) but also unusual in its blandness. Both Sunak and the leader of the Labour Party are widely considered to lack charisma, which accentuates their lack of a strong agenda. The topics discussed at debates include immigration (too much of it) and public services including the National Health Service (not enough of them). The Conservatives have been talking about generational culture war issues, cutting taxes for pensioners and reintroducing national service for 18-year-olds, and appear to be trying to fend off the right-wing Reform Party with plans to deport undocumented immigrants to Rwanda. The Labour Party is being very vague on policy, probably to avoid alienating the centre-ground voters.

There is an unresolved debate to be had over the philosophy of taxation, spending priorities and structural reforms. This could have been a unique opportunity to ask voters if they want the United Kingdom to be more like the United States, with low taxation and low social spending, or the European Union (EU), with higher taxation and strong social support services, including childcare, housing and education.

Whoever wins, the starting point is suboptimal. The economy has been barely growing, productivity has been poor since 2008, and wages have barely increased in real terms in the last 14 years.¹ Energy-driven inflation has been tough to deal with, and higher interest rates have added to the squeeze on consumers. Public finances are stretched, and the United Kingdom’s cost of borrowing is higher because of the misjudged budget² of September 2022. Higher taxes or more borrowing will be needed to finance any investment to repair public services. Besides, there is an urgent need to reinvest in its defence capabilities, increasing the financing requirements further.

The country seems trapped in a net of weak growth, weak productivity and relatively high inequality. Yet, both main parties are ignoring the obvious point—that all remedies will require financing via debt or increased taxes—or both. In the United Kingdom, the income tax levels range between 20 percent and 45 percent. The capital gains tax levels range between 10 percent and 28 percent. It seems likely that these might be harmonised, leading to a reduction in switching income to investment (in property for example) to minimise tax paid. Estimates suggest harmonisation could raise around £16 billion³ per year and given that only around 3%⁴ of UK adults pay this tax, it could be a politically astute move.

There is a general market expectation that the UK economy will grow out of this predicament, but painfully slowly, unless productivity can be boosted. One of the obstacles is demographics. The workforce cannot be easily increased, because the rate of female participation in the workforce is already at 72%.⁵ In addition, the country appears to have 9.4 million⁶ economically inactive people who are between 16 and 64 years old, more than before the COVID-19 pandemic. Separately, the seasonally adjusted unemployment rate in the three months to April was up strongly, at 4.4%.⁷

The fiscal constraints and the productivity issues are not unique problems, and the capital markets appear to be positive about the prospect of a change of government, in the expectation that policy direction will be pro-growth, but with a cautious approach to fiscal policy. Supply-side reforms, stability of economic policy and potentially a concerted effort to smooth relations with the EU could help build confidence and facilitate trade flows. Investors appear to anticipate benefits for banks, homebuilders, and food retail, but a cloudier outlook for energy, where Labour leaders have indicated they want to extend or increase the Energy Profits Levy.

The UK equity market is not especially cheap at a 12 month forward price-to-earnings ratio of 11.58 and its dividend yield of 3.7% is welcome, but not world-beating.⁸ Year-to-date performance suggests interest could be reviving and as inflation gradually eases, investors can likely look forward to a significant reduction in interest rates.

The fixed income market recognises that the Labour Party must be keen to serve two terms, because the party’s project cannot be delivered in four years, so fiscal orthodoxy is virtually guaranteed. The recent uptick in unemployment and the gradual decline in inflation point to a peaking in interest rates. Further, with the low likelihood of a repeat episode of Liz Truss’ “Stranger Things.” bond investors may feel comfortable with 10 year Gilts at 4.33%.⁹

Sterling has enjoyed a measure of stability, gaining some ground against the euro year-to-date, as markets expect the Bank of England to cut interest rates more slowly than the European Central Bank. A change of government, the perception of less friction in trade with the EU, and we believe the expectation of stability and orthodox policy direction could provide further support to British pound sterling this year.

Finally, the city of London, which has been on a downturn since Brexit as jobs and transaction volumes have moved to the EU and some exciting tech companies have chosen New York for their listings, seems to be in a mood of cautious optimism. There are a handful of initial public offerings pending, after Raspberry Pi, (a British microcomputer maker valued up to £540 million), including Shein (a Singapore based Chinese fast fashion company) and DeBeers (the South African diamond giant), rumoured to be spun off by Anglo American as part of a restructuring plan.

In a world where exchanges and economies evolve continuously, it does seem like there is a feeling of cautious optimism. It could be time to sing a later George Harrison song, “Here comes the Sun”!