(Bloomberg) — British stock index futures rose and the pound held on to recent gains after an exit poll showed the Labour Party has a clear mandate to deliver on its promise of greater economic stability.
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Contracts on the FTSE 100 Index rose 0.2%, while the pound was little changed around $1.276. Early results suggested the Labour Party is set to secure its long-predicted landslide election victory, with Keir Starmer set to become prime minister.
In the run-up to the vote, investors have been betting that a victory for Starmer’s center-left platform would mean an end to policy-induced market meltdowns. While Labor’s historic support for higher taxes and unions has traditionally been at odds with markets, traders are confident this time around that the specter of Britain’s government bond crisis of two years ago will keep the next government in check.
“For the first time in years, the UK will be a relative island of political stability and this will moderate risk premiums and asset market discounts,” Krishna Guha and Marco Casiraghi of Evercore ISI wrote in a note.
Trading in UK government bonds starts at 8am in London.
Read: See how UK banks and housebuilders are on track for election victory
The official election exit poll predicted that Labour would win 410 of the 650 seats in the House of Commons, the most since Tony Blair’s landslide in 1997. Prime Minister Rishi Sunak’s Tories are expected to be reduced to 131 seats, down from 365 in 2019, a result likely to see some of the party’s biggest names voted out. The Liberal Democrats are on course for 61, with Nigel Farage’s Reform UK on 13.
The exit poll is based on a mass survey of tens of thousands of people after they have cast their votes, making it generally more accurate at predicting the outcome of UK elections than snapshots of voter intentions conducted during the campaign.
A big win for Labour “should mean there is an underlying bidding tone for the pound,” said Neil Jones, a financial institutions currency salesperson at TJM Europe.
Before the vote, Labour put economic stability at the top of its manifesto and pledged to stick to tough spending rules. Rachel Reeves, a former Bank of England official who will become UK Chancellor of the Exchequer, said the government would not raise three of the UK’s key taxes on wages and goods.
Other promises included building more homes, setting up a public energy company and “repairing the relationship” with the EU – although Labour’s manifesto also ruled out a return to the single market or customs union.
Fiscal stability and an improvement in the U.K.’s relationship with the EU would be supportive for British government bonds in the near term and positive for the pound, strategists at TD Securities led by James Rossiter wrote in a note on July 4.
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“If the final results match the exit poll predictions, the pound is likely to be well supported in the coming days.”
— Ven Ram, cross-asset strategist.
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Still, the new government inherits a sluggish and fragile economy. While inflation has fallen back to the Bank of England’s 2% target, prices for services remain sluggish. And a recovery from last year’s technical recession appears to be losing momentum, according to the latest growth figures. But the BOE’s expected rate cuts in the coming months give bond investors another reason to favor government bonds.
A Labour victory has been widely priced in by markets, given that the party had enjoyed a commanding lead in the polls for more than a year before Sunak called a snap election on May 22. That didn’t change after the election date was set, leaving the pound stable, bond volatility low and equities hovering just above a peak. The FTSE 100 actually rose 1.5% in the past two days, the most in almost two months, while global equities hit a record high.
“Markets like certainty and so a decisive Labour victory will be welcomed,” Nigel Green, founder of asset management firm deVere Group, wrote in a note. “However, this boost is likely to be limited as markets have largely priced in the expectation.”
The calm on financial markets contrasts the U.K. with neighboring France, where President Emmanuel Macron’s decision to call an early vote in early June triggered a selloff. The yield premium on French bonds over safer German debt at one point rose to levels last seen at the height of the eurozone debt crisis. The move was reversed this week as polls showed the far-right National Rally unlikely to win an outright majority in a vote on Sunday.
“With other developed economies also facing political unrest, this huge majority could present the UK as something of a political safe haven for investors,” said Lindsay James, strategist at Quilter Investors.
It’s also a far cry from the years when British markets danced to the beat of political drama. The Scottish independence referendum, the Brexit vote and the years of difficult negotiations that followed sent the pound and stocks reeling. Meanwhile, at the last general election in 2019, investors worried about former Labour leader Jeremy Corbyn’s left-wing policies, including nationalisation and worker ownership of companies.
More recently, former Prime Minister Liz Truss’s package of unfunded tax cuts has roiled markets in 2022 as a sudden rise in bond yields triggered a sell-off in leveraged pension fund strategies. Gilts fell, forcing an extraordinary intervention by the Bank of England.
That event has played a major role for politicians ever since, with both Labour and the Conservatives preaching economic prudence during the election campaign. Former Labour shadow chancellor Ed Balls said the party had put itself in a fiscal “straitjacket” by ruling out both spending cuts and tax rises. And Starmer’s target for annual growth of at least 2.5%, which could help finance extra spending, has been criticised by economists as unrealistic.
Meanwhile, markets are watching closely for signs of additional bond issuance to generate funds. UK government debt is at its highest level as a percentage of gross domestic product since the 1960s, and Britain is already in the midst of one of its biggest annual borrowing sprees on record. Further increases could hurt investor demand for government bonds.
“For now, markets will be happy the election is over, and that should help market sentiment,” said Kyle Rodda, senior market analyst at Capital.Com.
–With assistance from John Cheng and Abhishek Vishnoi.
(Updates with context on global equities in paragraph 13 and chart)
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